Sample Newsletter: FAQ (Frequently Asked Questions)

FAQ: POORMANS BASIC STRATEGY: For new subscribers - a summary of some basic startegy.

1. Hold time strategy is intermediate term (2 weeks min to 6 months or longer) and as such I assume I will hold a stock at least 2 weeks (unless I have made an obvious mistake or fundamentals change - e.g. earnings warning, etc).

2. Diversification - I follow a practice of being diversified as a means to minimize damage from a warning or stock sell off (sometimes manipulated by short sellers such as we have seen in ELOS, CKCM and PARL in times past). This strategy works when the market is holding up but of course they mostly follow the market down as well if the market sells off and there are more positions to sell, which can be a disadvantage.  I don't like more than 10% any one position. I personally have several dozen small positions (2k to 3k on average), but some of those are speculative and a way to watch to see if they are worth mentioning later on.

3. I start with fundamentals first (daily manual screen of all earnings reports as released - with some help from a certain publication I cannot mention) and then I run the charts of fundamentally sound stocks on a regular basis, including the database of 100 stocks nightly. I don't use wizards custom screens, etc and update my database manually every Saturday and provide the 12 point ratings on the weekend update report (part II).

4. The stocks that look the best are updated each week (mid-week alert) with fair value (updated every other week), targets (highlighted for those needing extra help) and updated analyst estimates and reporting dates updated as companies report and as show on Yahoo financial. All model stocks are listed as well as a shopping list of stocks for those looking for additional stocks and which also could appear in the future in the model. The targets (fair value) listed in the mid-week alert are more accurate than the "target" listing, which is based on a pe of 23 and perhaps a bit conservative for some sectors.

5. The strategy section is normally updated each evening before the next trading day for stocks that might be bought or sold in the model and with target range. I don't change prices during the day and in 2005 every stock trade was listed in advance the night before and I'll try to do the same again in 2006. Sometimes things change during the day and you can get a better price or in case of a warning, not buy at all. Sometimes the stock looks good and you might consider paying a few cents more for it, especially in a positive market like the first 7 days of trading this year.

 

FAQ: How do I calculate a target?:

1. When we have an Analyst estimate - ASFI will be our example. You go to profile (click on ASFI) and then click on the industry (Consumer Financial Service) and on the right side you should see a PE of 13.3 for the industry. If you then go to key statistics you will see trailing pe (current) is 15.77 and forward pe is 11.58. The immediate term pe of 15.77 is higher than the sector and may be near its target short term. For the longer term (approx 1 year out) we use the forward pe and based on current price of 24.66 we calculate: 24.66 x (13.3/11.58) = 28.32 (and if it goes to #1 of sector then we get target of $31.15). A short cut but I put less reliance is to go to analyst opinion (at Yahoo) and they show a range of 28.67 to 30 or average targer of $29 (pretty close to ours - this time). Thus I am considering it as a buy for the modes as it also has one of the higher ratings of 9. (I like to put 80% of buys for model/portfolio rated 6 or higher). You should get about the same answer by multiplying the industry average pe by the next years earnings estimate (compared to forward pe usage).

2. When we don't have an Analyst estimate - ANTP and just like the previous example we go to the profile and click on the industry to get the information for the industry of PE 29.9. In this case we still use the current pe from key statistics of 16.77. Here we can only work on present data and for the target we take the current price of 14.22 and multiply by industry pe (29.9)/stock pe (16.77) = $25.35 target. It seems a little high but ya never know. There is not an analyst to compare it to, but at least we have an idea that the stock still has value less than the industry and thus decent upside potential. It also has a current rating of 7. If we get a buy on pull back (hit low of 11.68 on Friday) as we have it just above the 9 DMA at 11.73 (see model trading strategy page for chart to click on).

The theory is that a reasonably stock should be able to match the average of the industry (peers) and we hope that we are finding even better than average stocks, but to be conservative we will use the average for out targets and if it is #1 in its IBD sector, then we add 10%. ASFI is #4 of 42 (see Target report or go to IBD stock check). (After a day of trading the numbers will change slightly as stock price changes.) If you want short term targets then use the trailing pe (last 4 quarters reported) and if you are longer term then we use the next fiscal year estimate, but it might take a year to hit the target if it performs as estimated.

When to HOLD and When to FOLD? I think the time has come to discuss this most difficult questions as I have seen it come up several times already. I don't have a pat answer, but I think there are 2 situations that cover most situations. One is when you have a broad range of stocks and the other when you follow the IBD style and only have 4 to 5 or less. In my case I have most of the model stocks and about twice that many more as I have a few shares in a lot of stocks as it helps me to find potential winners. Sometimes I get burnt such as BDCO which I took a 50% loss today on 200 shares when I realized it had a bad report and I still had some shares. This is a general rule and not one for special situations such as right in front of earnings.

Diversified Situation (especially 8 or more positions). Unless the market is in a recession or clearly tanking and headed below 200 DMA supports (Only the Nasdaq is below 200 DMA currently) then my decision is based more on value and long term potential. What I do in this case in a weak market is look for fair value, Poormans rating (ideally 6 or higher) and current and projected growth.  Then I tend to fine tune by eliminating the weak stocks and hanging on to the stronger ones. This situation would apply when you hold all or most of the model stocks. In the case of a recesson like we had in 2001-2002, then it can get very painful as you don't see it coming sometimes, especially when it lasts so long. However, even those stocks and portfolio came back in 2003 and 2004.

Focused Situation (concentrated holdings in a few stocks). In this situation you can't afford to take a big drop.  It has been many years since I only had 5 stocks or less but if I did, then I would be inclined to use a trailing stop (preferred as market makers can't see it) or a mental or even hard stop. In the case of stops I like to put them under the support and it might be a 4 to 10% loss point as I really don't pay much attention to 7-8% sell rule. If I have a large gain I might raise it above where I purchased to lock in profits if they look at risk. If it is a model stock such as MFLX and let's say I had bought at 50 then I might have a sell stop (or trailing stop) set at 48 for illustration purposes (without looking at the chart) and if it goes out, then I can wait for the model to work its way back or if it sells, you are already out of it. The problem with stops is to know when to get back in. If someone has all the model stocks they only have 5% in each stock but for 4 stocks, you have up to 25% in each stock and much higher risk. It closed at 32.63 today and if you were in cash and the model looks like it will continue to hold after it has broken down trend and started back up, then you could get in around 38 for example. You can't afford to ride a stock all the way down when it is 25% of your portfolio. In this kind of market you very well mind find your self in all cash, which is ok as you have the model for a reference on when to get back in.

FAQ: What about trailing stops?: One of the toughest aspects of investing is knowing when to sell and that is no different with the professionals. I am not discussing selleing per se today, but rather a review of using trailing stops vs normal stops. The advantage of a trailing stop is that the sell price is listed only in the brokers software and not visible to market makers, who have been down to dip the price to take out visible stops. Now they have to know there are also invisible stops that they might catch with a quick dip of a stocks price, but they are guessing in the dark. Many times I have had my stop taken out, for the low of the day and the price immediately went back up. Here are some thoughts in regard to trailing stops:

FAQ: How do you find good stocks for pull back buys? This was sent to me this week and perhaps others have the same question. I would that all my subscribers continue to learn and improve on their own research and gain confidence. As John the Baptist said, I must decrease so that He (you) can increase. It is my goal to teach you the methods rather than have you rely on me. Someday my eyesight could go or anything healthwise is possibe as I will be 61 on 29 May and would like to continue what I am doing for another 4 years or so, Lord willing. Here was my answer to the question:

I'm not sure I have anything like rocket science, but here are some of the factors considered, and I'll use IVAC for an example.

1. Familiarity with a stock (some DD always helps) as I keep a database of 42 data elements on each of 100 stocks. But you get the summary of that effor in rating form and seeing a rating of 9 is a good start point. I like 80% of buys to be rated 6 or higher and 20% maximum for stocks less than 6 rating.

2. It needs to have upside fair value at least for a long term hold. IVAC is a leader in the group so I listed it particularly (in model and fairly close to f.v.) with near target of 31.79 and long 43.91. Thus I have underlying funamental strength.

3. The industry group has a top rating and top relative strength along with RSI 57.2 (over 50 shows more buyers than sellers). It don't have to be the highest rated industry but you like to see it a least above average. In case of IVAC it has street interest that exceed selling interest.

4. Keep one eye on the market and cyclical mass selling (in earnings season) as that is a red flag but also gives buying opportunities. When the indexes go down the supports like 9 DMA aren't likely to hold. IVAC also had a gap to 26.20 that was filled and it managed to hold 21 DMA. It is a little dangerous to buy a down trend and support bounce, but if we hit it right it can pay nice dividends. I tend to use partial buys when it hits 21 DMA for example and add the rest when it breaks the down trend and starting back up.

5. I watch for supports, including filling gaps. But support may be DMA, lower up trend line - in IVAC case the daily chart over 4 months shows a lower up trend at 23 and about the same as 50 DMA (concurrent supports are good). Short term trend roughly parallel to 9 DMA was broken so we look to the next level as described in previous sentence.

6. I also like growth of 20% or higher as extra incentive and IVAC has 32% for 2006 and 35% for 2007.

Those are some thoughts off the top of my head that contribute to a pullback buy decision, although I might not consider all individual points all the time. This is especially true when I do the weekly shopping list, as it may focus more on the technical chart than street interest for example as pull back buys are usually fairly conservative.

How to use Relative Strength Index (RSI)?:  A popular oscillator developed by Welles Wilder, Jr. and described in his self-published 1978 book "New Concepts in Technical Trading Systems". RSI is plotted on a vertical scale from 0 to 100. Values above 70 are considered overbought and values below 30, oversold. When prices are over 70 or below 30 and diverge from price action, a warning is given of a possible trend reversal. (See Glossary at stockcharts.com)

You see my referring to the RSI quite often as I became interested in it after an impressive lecture by Chris Manning at the Las Vegas Money Show about 4 or 5 years ago. He did extensive research on thousands of charts (as did William O'Neill) and one of his findings was the use of 50 RSI indicator. Now I use the 21 day for intermediate term investing (2 weeks to 6 months or longer) while the default is usually 14 days. For a day trader you might use even 5 or 7 days. What Manning found was that 50 RSI is roughly the dividing line between sellers and buyers with more buyers in the stock over 50 RSI for example. I use this indicator more than the 30/70 by Wilder, although it is of some useful information. What the "Manning indicator" would say is that when a stock comes up through 50 RSI it is a "flag" to look for another technical indictor or exceed the most recent high.

JLG - will be our example (click on symbol to see chart) and I wasn't following it at the time, but it shows a good example of how to use the Wilder RSI. The RSI chart is at the top and shows 57.0 currently and also has 3 arrows pointing at period when it went up through 50 RSI. The first arrow as a gap up and probably wouldn't have been usable at the time (extended) and the second arrow from the left is premature (false move) as it wasn't accompanied by technical indicators. The 3rd arrow is the one we will discuss as it points to the move up through 50 and accompanied by 3 technical indicators indicated on the box. The early buy point can be the breaking of the trend line or the next is .10 above the previous high of 21.70 and actually all 3 indicators occured on the same day 5/18/05 as it broke out on a little higher volume than it had been running but wasn't 50% higher than average (only about average actually). Since then you can see how it found resistance at 70 RSI several times, even though it punched through a few times for a brief period of time. Since then it is up 64%, even in a tough market. Again a combination of strong fundamentals and technical analysis for someone who happened to pick up on the buy point at the time as I just recently added to the database.

FAQ: What about Trailing Stops?: One of the toughest aspects of investing is knowing when to sell and that is no different with the professionals. I am not discussing selleing per se today, but rather a review of using trailing stops vs normal stops. The advantage of a trailing stop is that the sell price is listed only in the brokers software and not visible to market makers, who have been down to dip the price to take out visible stops. Now they have to know there are also invisible stops that they might catch with a quick dip of a stocks price, but they are guessing in the dark. Many times I have had my stop taken out, for the low of the day and the price immediately went back up. Here are some thoughts in regard to trailing stops:FAQ: What are support areas and how do I use them? This is a bit long and we will use HW for an example:

1. One area I use is when a stock has hit fair value area and I am prepared to lock in my profits. For example I had some SIMC that hit fair value at 11.78 this week and ran a little over 12 when I spotted that it was over f.v. It was in my IRA so I wanted to get 11.75 for it and it was at 12.05 at the time so I put a trailing stop at .30 and GTC order. It didn't take that day buT on Friday it filled at 11.80 and a little more than my minimum desired before it dropped to 10.51 low. The point was I protected my gains and had it gone over 12.30, I would have gotten at least 12 for it.

2. Lets make up an example of a stock less than fair value and I want to protect my position with a tight stop, but still have it go higher if the stock goes higher. HDNG closed at 34.08 and had a low of 33.06 on Thursday (see on 60 min chart) and so I'll use that for support and go a little below it. In this case I might say 32.98 is where I would like a sale on a dip (making it go through some support) and so I would put a trailing stop of 1.10.  

Now there is no guarantee that a sell will hit that exact price as it becomes a market order when tripped in the brokers software program. A gap down and it could be filled at a lower price or it might even bounce a few cents before being filled. I don't normally use a lot of stops and mostly when I am ready for a sell or there is a possible question in regard to a particular stock. I might use a few more stops when I am on vacation and away from the market as well.

 

1. One area I use is when a stock has hit fair value area and I am prepared to lock in my profits. For example I had some SIMC that hit fair value at 11.78 this week and ran a little over 12 when I spotted that it was over f.v. It was in my IRA so I wanted to get 11.75 for it and it was at 12.05 at the time so I put a trailing stop at .30 and GTC order. It didn't take that day buT on Friday it filled at 11.80 and a little more than my minimum desired before it dropped to 10.51 low. The point was I protected my gains and had it gone over 12.30, I would have gotten at least 12 for it.

2. Lets make up an example of a stock less than fair value and I want to protect my position with a tight stop, but still have it go higher if the stock goes higher. HDNG closed at 34.08 and had a low of 33.06 on Thursday (see on 60 min chart) and so I'll use that for support and go a little below it. In this case I might say 32.98 is where I would like a sale on a dip (making it go through some support) and so I would put a trailing stop of 1.10.  

Now there is no guarantee that a sell will hit that exact price as it becomes a market order when tripped in the brokers software program. A gap down and it could be filled at a lower price or it might even bounce a few cents before being filled. I don't normally use a lot of stops and mostly when I am ready for a sell or there is a possible question in regard to a particular stock. I might use a few more stops when I am on vacation and away from the market as well.

 

1. Notice the horizontal line which I know from DGO graphs that the low points for a triple bottom were: 27.53, 27.87, 28.01 from 8 Sep to 13 Oct. This would be considered normal support as it bounced off it 3 times. Therefore, the support would be a little below 27.53  (say 27.45) but that is also 12% below where you bought it at 31.14. Peter Lynch allows 25% drop for a good stock and doesn't sell until fundamentals change, and I tend to follow this thinking for longer term investing.

It had pretty decent support at $30 but dropped through it recently and hit low of 29.10 and in this case works as some support in case of another drop. Since many sellers use even numbers, I would be inclined to go just below $29 and probably 28.85. (End of day stops are much safer from being ripped off by the market maker (note recent CTSH action - excellent example). In this case it is 7.7% below you buy price and a reasonable stop (not all the way to $20). I like this stock long term so I don't see any need of using a tight stop. A real tight one would be just under support at $30, say 29.95 but that is a little more dangerous.

2. The parallel lines are 'trend lines' and that is another type of support at the lower up trend line and it represents the trading range for the past 15 months or so and gives a reasonable projection of what we might expect in the future, barring a major change in events or fundamentals. It is coming in a little lower than 27 on the chart and that is another way to set a sell stop (mental - end of day, or a regular stop that is seen by market makers). A preferred or alternate method is the trailing stop and let's say you use 3 points. If the stock goes to 34, then the sell stop becomes 31 and if it goes to 35 then the stop moves to 32 and you are fairly well assured of a small profit anyway, barring an after hours publishing of bad news and it gaps down. A stop becomes a market order and in a gap down, you have to take the price of the first buyer anyway.

3. The 21 DMA has held up fairly well and 29.16 is its present value, so again a stop of 28

CHART FORMATIONS: One of the strongest formations is the High Tight Flag and I’ll first give you the criteria from Bulkowski’s “encyclopedia of Chart Patterns”, page 231.
1. Substantial Rise: A rise lasting less than 2 months carries prices upward at least  90% (shoot for a doubling of the stop price). Stocks with 2 month rises over 115% perform the best.
2. Find consolidation - Locate a consolidation area, an area where prices pause in the prevailing uptrend.
3. Receding volume in trend - The volume trend in the flat should be receding for best performance.
TRADING TACTICS (P. 237)
1. Measure rule – None. The formation can act as a halfway point. Use that as the benchmark but be conservative in your estimate.
2. Buy after breakout – If prices break out of the flag portion, buy the stock,. If you cannot tell if a breakout has occurred, wait for prices to rise above the highest high in the flat.

Let’s use an example: BOOM

Although O’Neil uses a 3-5 week duration for the flat and maximum of 20% decline, Bulkowski model did not put a limit on the pull back nor on the duration, only that a consolidation was visible as in rules 1-3 above. For 115% flag pole rise (Boom was 400%) the average gain is 93% from high of flagpole and on Friday BOOM closed at 37.30 or up 112%. (There is a 17% failure rate even for those breaking from consolidations). It was Poormans Stock of the Week on 2/25 as it opened at 15.24 and closed at 19.41 after a strong earnings report on 2/22. We just missed a small pull back buy for the model that day and the following week. It may be getting a bit pricey now and subject to the whims of momentum players, although Vector Vest gives it a target of $41, I have been told.

FAQ: What about Ascending Triangle Chart Formations? I have seen some questions on this popular formation this week and although I may have discussed previously, I'll use LDSH as an example. Technically it looks great but fundamentally it is not far from fair value and we currently are looking to lock in profits in it in the model. But for some there are some positive things to watch for if you decide to continue holding like I probably will. (Click on the symbol to see the chart). For reference I'll use Bulkowski's "Encyclopedia of Charts" and page 514 in particular. Similar principles apply to descending triangles as they usually break to the down side. NOTE: IT IS HARD TO GET A BO IN A DOWN MARKET AND THUS LDSH ATTEMPTED TO MOVE UP BUT THEN WAS PUNISHED FOR FAILING TO BREAK OUT.

IDENTIFICATION CHARACTERISTICS OF ASCENDING TRIANGLES:

1. Two price trendlines with the top on horizontal and the bottom one sloping up - headed for an apex. In the case of LDSH the lines are narrowing and as the trading ranges narrows the move up or down can be sizeable.
2. For the horizontal line the prices need to touch or nearly touch it at least 2 times (nearly 6 times so far in our example).
3. For the up sloping line it needs at least 2 tests and LDSH shows 4 tests of the up trend line (higher lows along the up trend line).
4. Prices should cross between lines several times and not leave a lot of white space. (the last 3 weeks sh

 

1. One area I use is when a stock has hit fair value area and I am prepared to lock in my profits. For example I had some SIMC that hit fair value at 11.78 this week and ran a little over 12 when I spotted that it was over f.v. It was in my IRA so I wanted to get 11.75 for it and it was at 12.05 at the time so I put a trailing stop at .30 and GTC order. It didn't take that day buT on Friday it filled at 11.80 and a little more than my minimum desired before it dropped to 10.51 low. The point was I protected my gains and had it gone over 12.30, I would have gotten at least 12 for it.

2. Lets make up an example of a stock less than fair value and I want to protect my position with a tight stop, but still have it go higher if the stock goes higher. HDNG closed at 34.08 and had a low of 33.06 on Thursday (see on 60 min chart) and so I'll use that for support and go a little below it. In this case I might say 32.98 is where I would like a sale on a dip (making it go through some support) and so I would put a trailing stop of 1.10.  

Now there is no guarantee that a sell will hit that exact price as it becomes a market order when tripped in the brokers software program. A gap down and it could be filled at a lower price or it might even bounce a few cents before being filled. I don't normally use a lot of stops and mostly when I am ready for a sell or there is a possible question in regard to a particular stock. I might use a few more stops when I am on vacation and away from the market as well.

 

FAQ: REPEAT Please explain "bid and ask" and the spread? We had a request first in regard to what to buy when coming from cash and I provided some suggestions (point #4) in addition to the 3 points that have been in place all year in the MIDWEEK ALERT. That last request related to bid and ask. Here are the definitions from NASD glossary of investing terms. I'll even add the definition of the market maker, often mention on the chat boards.

BID PRICE - (or buy price) is "the quoted bid at which the Market Maker is willing to buy a stock."

ASK PRICE - "the price at which an individual is willing to sell a security."

BID/ASK SPREAD - "The difference between the price at which a Market Maker is willing to buy a security (bid), and the price at which the firm is willing to sell it (ask). The spread narrows or widens according to the supply and demand for the security being traded."

MARKET MAKER (MM) -  A firm that maintains a firm bid and offer price in a given security by standing ready to buy or sell at publicly quoted prices. The Nasdaq stock market is a decentralized network of competitive Market Makers. Market Makers process orders for their own customers, and for other NASD broker/dealers; all NASD securities are traded through MM firms. MMs also will buy securities from issuers for resale to customers or other broker/dealers. About 10 percent of NASD firms are MMs.

As you can see from the definitions that heavily traded stocks tend to have tight spreads (difference between bid and ask, perhaps 0.10) while slow trading often results in spreads of 0.40 or more). Also if someone puts in a market order to sell the MM has to either buy for their own account or fill from open orders and sometimes has to drop quite a ways to find enough buyers to fill the order. When buyers see bargain prices they quickly jump in and sometimes you see a big dip for about a minute and then it jumps right back to regular price. We ofter blame the MM for "stealing our shares" but it could have been caused by a large block sale from an institution or a hedge fund for example.  EXCELLENT QUESTION