The big question on everybody’s lips when a market corrects and perhaps goes past you stop, which of course you may execute, or you may not, is will it go down further or turnaround and go back up, again. The reality is it doesn’t matter (we’ve moved on) because that thought process is destructive and unnecessary. Give your mind a break. But I do want to take you through a process of awareness and understanding that might frighten you enough so that next time your stop is hit, you will more than likely execute it.

Risk Management is a process that requires undistracted focus. Firstly, who remembers the Covid driven online mania, the Internet Frenzy of the 2000’s of in fact any price mania that disappears faster than it develops. Yes, vivid in our memory are some and the mistakes we made because the frenzy ‘made us do it’. Double speak for I got caught in the downdraft after buying at the top of the updraft. Well maybe you didn’t buy at the top, but I know of many who got caught in the downdraft – and big it was, but also unnecessary. Don’t forget sell the greed and buy the fear, not the other way around. Sounds easy, doesn’t it?

I only know this because humans’ traders continue to make the same mistakes for many reasons and have for a long time. The trick of a good trader is to recognise and change the biases or habits otherwise you will continue to lose money making the same mistakes. Sometimes we find it hard to control ourselves because the human element is full of biases and emotions. Understanding that need for change is an important trading and life changing milestone to reach.

Common traits to note of the four stocks below: TPW, KGN, MP1 and APX.

1. These stocks were all under ‘mania’ conditions
2. Big uptrends are followed by big downtrends
3. We know price / investor behaviour always follows a similar path of boom and bust.

You need (to be in) Total Control when you trade these (very lucrative) momentum moves.

Check the charts out below.

I’m not going to focus too much on the indicators but rather this is about price levels and risk management. It’s simply not an analysis thing.

MP1, wonderful stock you say as did many in the ‘advisory’ community spruiking its unique method of delivering its network services. But what ‘they’ don’t tell you is that despite it being a ‘great’ company with a potentially great future the fact is the share price (of all stocks) will go both up and down over various time frames and magnitudes regardless of the company’s performance. And if we study price behaviour, we find out why. Investors are the market, and it is their behaviour (perceptions) that will decide the fortunes of the share price, not necessarily the fundamentals. They are merely one piece of the puzzle that goes into the decision-making process.

We need to be alert to the behaviour of investors, understanding the repetitive nature of their behaviour, can be a big advantage.

Price is excitable. It moves in booms and busts, as we do. Either the price got too high for some of these stocks, or they were not delivering enough to justify the price. Ho hum here we go again. A pumped-up business (P/E) with some great aspirations only to stutter and fall back unceremoniously. Sadly, a repetitive behavioural performance we should know only too well.

TPW and KGN provide clear and simple responses to a mania. In this instance, as if Covid would never end, these online retailers were driven hard and fast and into the valuation stratosphere. The upside momentum swing is a wealth generator to behold just be wary, and ready, for the withdrawals. How much are you willing to risk?

The trailing stop is not a ‘knowing’ thing, it is merely a physical measure of risk we are prepared to take on any one trade. Nothing to do with ‘good’ analysis so once it goes past that point of accepted risk why would you hold? But and the big but is, stops prevent big losses. Fact.

Point in case? In fact, there are four of the little darlings below all of which suffered the same boom/bust price action. The why is unimportant but the fact of it is. Some stocks will collapse, some won’t and we don’t always know which ones but under this ‘mania’ scenario there is compelling evidence from the price behaviour of these four stocks that a significant price adjustment reaction to the huge gains is inevitable. Whatever, any trend must be protected to prevent the large losses which means every stop that is hit we take because we never know where the share price will end up. I have sneaking suspicion there are many investors with a few KGN’s in their bottom drawer. Now at $$4.00 we wonder how long it will be before we see $24.00 again. It took just under 2 years to deflate the price from $24.00 to $4.00.

TPW has a triple top failure below $12.00, KGN a lower high failure below $20.00, MP1 a little harder to read (thankfully we have a stop), and APX just slid disastrously from a lower high failure below around $32.00. Still in each case the stop takes precedence over analysis but it was clearly there to support the case.

Big momentum moves are built on promise and expectations with high, and probably unsustainable P/E’s, ripe for adjustment when the wind changes. So if you ride these big waves, and, yes, we try to ride them as they’re money making opportunities, be sure to jump before the tide goes out. In fact in each of these cases the evidence was compelling before the falls that a neutral position would be wise. But then there is the stop just to make sure. Sometimes greed makes us blind, so being able to see the reality of what is on a chart is a discipline in itself. Thus the ‘unfoolable’ Trend Intensity Rating our great perspective barometer. It’s a great tool for gaining perspective because it tells it like it is, not like what we want.

This build-up of unrealised profit must be managed to a realised position in a timely and controlled manner. It must not escape. Our risk management process ensures we do this and this is a vital aspect of trading, maximising / locking in, those wins.

At least next time you might have a bit more knowledge to be aware or alert to these situations and you then might also need to control and resist what might be some overzealous sentiment. That’s usually when the smart money is exiting.

As a matter of interest 3 of these stocks (not MP 1, although it did spike last week on good results) are now showing accumulation patterns at these vastly discounted prices. If you think any one of these might still be a good business proposition maybe now we can start considering what the share is doing, or going to do at these vastly discounted prices. Now this is an exciting prospect, and the risk has come down significantly. The cycle will go around again, and again.

Stock Cycle: Uptrend, Distribution, Downtrend, Accumulation, and then back to Uptrend.

Next Issue of the Radar Newsletter:

This article has glossed over one very important area of trade management and that is the ‘why’ we have the need to follow these stocks down, down, and down. Why don’t / can’t we get out when we can see clearly the stock is going against us. Yes, we ‘cut the flowers and water the weeds’ all the time it’s called the disposition effect and over time that will bias your portfolio to increase your weight of losers over winners. Our natural human instinct is not a complimentary trading skill even though we mistakenly think it is sometimes. It is one that needs to be managed and controlled very carefully or the disposition effect will take control of your portfolio and ruin it. It is unfortunately ever present and thus the control dial is essential. An understanding of the effect on our actions will possibly help you not only set those stops but listen more carefully to them.