2 Simple Rules Revisited
PowerRatings (for Traders) offers traders a simple, easy-to-use indicator
that provides a simple edge, which has been quantified by millions of historical
trades. On its own, PowerRatings are a great way to get a feel for an individual
stock’s probability of being higher or lower in 5 trading days.
Earlier this year, CEO Larry Connors and Editor in Chief Ashton Dorkins put
together an article explaining 2 additional rules which could be used with
PowerRatings (for Traders), which dramatically increases performance results.
Let’s take a look at these 2 rules, and focus on how we could use them in our
trading today.
Here are the rules:
1. Only buy a high PowerRating stock (7
or higher) on a limit order below yesterday’s close.
2. Instead of using a static exit and
waiting for five days, use a dynamic price exit by exiting the trade when the
stock closes above its 5-day simple moving average (SMA).
These rules sound simple enough, but the underlying principles involved are
what’s important. PowerRatings (for Traders) are, in a nutshell, geared towards
finding uptrending stocks that are pulling back. In other words, we are looking
for stocks that have been rising over the past few months, that have suddenly
reversed their comfortable rallies. As the stock price falls and the conditions
(RSI and other proprietary indicators) become more and more extended to the
downside, the PowerRatings rank will increase. A strong stock that has fallen
for a few days will have a better PowerRating (for Traders) than a strong stock
that has risen for a few days, because historical data tells us that stocks
usually revert to their mean conditions. So as price gets further and further
away from the norm, the odds increase that price will move back into its
original range.
So in Rule #1, we only focus on stocks with PowerRatings (for Traders)
of 7 or higher. Basically, this ensures that we are trading in stocks that are
primed for a pullback, versus a stock that is aimlessly drifting, or one that
has a bearish edge.
Then, we wait for the stock to become more extended before buying.
Imagine a stock that has fallen for 4 straight days, and has a strong
PowerRating (for Traders) of 8. Despite being a relatively strong stock, prices
have been falling fast for a week. As the market opens, traders are literally
waiting at the doors to get out of this stock, and as they do, prices fall even
further. After falling an additional 3% from the previous close, the
institutional buyers step in to take advantage of this great new price.
This stock has been uptrending for months; there is no real weakness here in
the stock itself, only panic and fear in the market. The big boys on Wall Street
are chomping at the bit, waiting and waiting until price falls far enough for
them to jump in. This type of market action has repeated itself millions of
times, and the odds favor the fact that it will continue to do so. It’s a good
idea to step a market limit buy order at a pre-determined price, so that you
don’t get caught up in the panic yourself, and fail to pull the trigger. When
the odds are on your side, it makes the psychological aspect of trading much
easier to deal with.
In Rule #2, we exit the stock as soon as the short-term rally has
become overbought. In the first part of the equation, we buy as the stock falls
to extended lows, i.e., oversold conditions. Prices dropped, so the odds favored
a pullback snap. On the flip side, as prices jump, conditions then become
overbought, which creates a bearish edge. Just as oversold conditions led to a
price spike in the first half, as prices accelerate, we will be looking to get
out to avoid the overbought selloff. The 5-day moving average is a perfect
indicator for this, because it is short-term price gauge, and its simplicity
paints a clear picture. Get out after the stock moves.
Check out Steven Primo’s
PowerRatings (for Traders)
presentations to learn more about PowerRatings.. Click here to read the original
2 Simple Rules to Improve Your Trading.