I read about 5 books or so, a few blogs, watched some videos, and such before I finally came across something that I believe to provide an edge.
Read “how I earned 2 million in the stock market”. Was about buying momentum stocks after they trade above a range and having a stop $1 below the price and advancing it to the low of the next trading range that is made. Didn’t really learn a whole lot, but emphasized the importants of having a system, not being afraid to buy stocks at new highs, and using stops to both prevent losses and protect profits.
The book reminscence of a stock operator was good, and helped me understand that buying stocks higher and pyramiding as stocks rise but advancing the stop, general things like “hold your position throughout a bull market, or bear market”. But the book didn’t really leave me feeling I had gained any huge edge, just some things I could maybe carry with me on my quest.
The next book Encyclopedia of Chart Patterns was big for me. I’m a mathematical guy who excelled in statistics classes when I took them, even though that was a few years ago. Nevertheless, I never really had thought about the most basic things such as what’s my upside? What’s my downside? How likely is my trade to produce a “win”? How can I increase my upside without limiting my downside? This in combination with O’Neil’s book were the two books that really helped me identify what I believe to be a system that has an edge.
The book “How to Make Money In Stocks” always appealed to me, and was one of the first books I read… but it lacked the statistical data and results of the study leaving me skeptical, and plus I never really could grasp everything the first time. However, I noted several things that seemed important, allowing me to come back to this book. after I had read Encyclopedia of Chart Patterns and things really made sense to me. Additionally, the data at IBD index blog, particularly the one talking about multiple stops comes to mind, (and some of woodshedder posts here on IBC) helped me better grasp what I was trying to accomplish and really helped me wrap my mind around what I view to be important about O’Neil’s system, which is the rules of cutting losses at 8%, waiting 8 weeks (which is a step I had missed before) and THEN taking wins at 20% (or waiting until you can take a win at 20%.) was a crutial idea for this system.
A book I am currently reading is Trading for a Living, which I find very interesting and useful in terms of the psychology (one thing that I find interesting is how it comparing losses to a losing trader as alcohol to an alcoholic) that may be useful to understand, but as of now it does not apply to my system at all other than a reminder to keep the stop in place and not really deviate from something that has the math behind it.
So with that in mind, I started to look right away at the most profitable and reliable chart pattern mentioned both in How To Make Money In Stocks, and Encyclopedia of Chart Patterns.
This is “high and tight flags”. So what did I have to do? I had to find both a way to identify the high and tight flags fairly quickly, and also I needed a set of rules that would make things profitable.
But first, some info on high and tight flags…
This is just about everything you want in a trading system. You want to be able to put money in the winning, top performing leading stocks in the market at a reasonable buy point. You also want to be able to add to your winners as they act well and go higher, rather than keeping money in the laggards within your portfolio. But there’s a fine-line between adding to a winner and putting money into an over extended stock you should be selling. The way to do this is to buy first as the stocks break the downtrend, then buy as stocks break to new highs. This way you aren’t putting in a double position unless the stock proves to you it can perform, and new highs are actually a solid buypoint that can be made after a base is formed from the consolidation. You want a high probability of success and a high move upwards. High Tight Flag Patterns offer you just about everything you look for, and that’s before you even put many rules on it.
O’Neil’s guidelines are different than Bulkowski’s in Encyclopedia of Chart Patterns. a 20% consolidation from the peak is acceptable and a consolidation period where prices pause doesn’t have to be any length of time to qualify. Additionally, a rise of at least 90% rather than 100%-120% is acceptable, and any more than 120% is also acceptable.
Now with those numbers in mind, we can see that if we can develop a system around these flags, we should see a lot of success if we can do things right. The details of how to identify these rockets, and how to get in as they make their breakouts, and how to make sure we are limiting losses while letting gains run is going to be determined in the next post.
Part 1 how to identify high tight flags
Part 2 flag trading system rules
Part 3 Concluding the high return investments system.
I like it, although I think as a general money management rule, staying away from biotech is a good idea. Look at the horrer story of ARNA. Sure, it’s an outlier to this system as the past data on high and tight flags clearly show, but look at what happened to ARNA which made it’s first breakout (but not it’s second). It hurts when you have a system set right with the right stops and everything but still get hit by some unforseen event such as a suddenfinding that the dru everyone assumed was going to be approved by the FDA has potential dangers to the users health.
Even so, your damage would be minimal with good rules and money management because you would have only made one buy rather than 2, your position size would be small, and even though you would have had to sell below your stop due to the large overnight drop, you would have sold before it dropped so much more.