I thought I’d spend today taking you through an actual share trade that I sent to my Slipstream Trader members last year. We’re still in the trade so I won’t reveal the actual stock code, but it won’t take a genius to work out which stock it is.
Therefore I have to add that this is not a recommendation to buy this particular stock right now. For me the opportunity to buy this stock with a very good risk/reward has passed. We have already taken part profit on the share trade and adjusted our stop losses so that none of our initial capital is at risk in this trade going forward.
Buying the stock now would be a completely different trade with a different set of risk and return characteristics. I want to point this out so you don’t mistake this article for a recommendation to buy the stock.
The purpose of this article is simply to give you some practical insight into how I go about selecting trades on the Australian share market…
Analysing the Price Action
This company is an oil and gas company worth well north of a billion dollars. I’ve liked the stock for the past few years and have actually traded in and out of the stock for profit on multiple occasions before this trade occurred in June last year.
When making a decision to enter a stock I need to have both the fundamentals and technicals going my way. I think it’s necessary to combine the two in any trading decision because relying on one or the other means you are only reading part of the story of the stock.
The volatility of stock prices is so intense that a purely fundamental approach will often get you into trouble. That’s because the volatility will either shake you out of the stock at the wrong time or you’ll need to risk a large portion of the stock’s price since you have no idea of when you’re proven wrong.
On the other hand, being purely technical means that you could end up playing with fire by buying a stock that is fundamentally unsound.
Here’s a weekly chart of the stock in question going back nearly ten years:
Weekly Price Chart
Weekly Price Chart” border=”0″>I’ve included some horizontal lines on the chart to show you how I analyse the stock’s price technically. The key levels are the solid blue lines based on the range created all the way back in 2006 between $1.00 and $1.64. The dotted line in between is called the ‘point of control’ and is what I see as the gravitational point around which all of the subsequent price action oscillates.
Using this method I have a point of reference for analysing the past ten year’s price action.
It’s very interesting to note that the low reached in 2010/2011 was exactly 61.8% (A Fibonacci level) below the upper distribution. This relationship is a very important one. Based on this relationship we bought this stock at 74c and rode it up to over $1.00 in late 2010 to early 2011.
I think it’s an amazing thing to see that there is a set of underlying relationships that explain this stock’s entire price move over a period of ten years. If you understand this relationship it becomes far easier to see where an opportunity lies and where danger lurks.
When looking at the chart above where would you like to have bought the stock over the past year?
Slipstream Trade Entry Point
Slipstream Trade Entry Point” border=”0″>The point at ‘X’ on the right side of the chart is where we bought this stock, based on a retest of the bottom of the major distribution that the stock had been in for years. The most important thing to note is that the risk taken on the trade was only 20% of the stock’s price. The entry point was $1.05 and the stop loss was set at $0.85.
In fact the stock sold off to $0.895c after we entered the stock, just 4.5c above our stop loss. I think this shows that the stop loss level was set at the right level to withstand a move against us.
The initial profit target was set at around $1.30 because that price was equal to the stock’s ‘point of control’. The probability was high that we would at least see a return to the point of control and therefore taking part profit at that level makes sense.
We took a third profit at that level and adjusted the stop loss to a point where, if the stock hit it, we wouldn’t have lost any of our initial capital. So from that point on we effectively had a free option to see what would happen to the stock.
By creating the free option it lowers our stress to a negligible level. We know that we’ll either make money or lose nothing, so we can relax and let the stock do its thing.
The Keys to Trading the Equity Market
Ultimately the aim of the game is to plant as many of these seeds as possible and then sit back and hope that one of them goes ballistic and hands us some big gains. You never know which ones will be a home run but you can be pretty confident that sooner or later you will get a few king hits.
We will take some more profit if the stock hits the next profit taking level so that we’ll be certain of at least making some money on the trade or making even more money. That’s a very powerful position to be in.
Fundamentally the stock has exposure to some serious upside in the form of shale gas so this may be the beginning of even bigger gains. We’re now in the box seat to participate in those gains without having a heart attack every time the stock pulls back in price.
Hopefully this gives you some insight into the decision making process involved in trading the equity market. There are a hell of a lot of moving parts, so you need to whittle the noise down to some overriding principals that make sense. Then you can enact a strategy based on probabilities and risk management…rather than your gut feelings, which are often wrong.
Murray Dawes
Editor, Slipstream Trader
Murray Dawes
Editor, Slipstream Trader
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