PowerRatings, Position Size and the Breakdown Trade
I got an e-mail from a new PowerRatings subscriber last week that brought up an issue that I have addressed in the past: what do you do when a trade drops below the 200-day moving average?
This is relevant because our high probability approach to trading means that we never buy stocks or ETFs that are trading below the 200-day moving average. Our historical backtesting, going back to the mid-1990s for stocks and since inception for the most liquid ETFs, confirms this over and over again. There is no edge in buying stocks below the 200-day moving average.
But what do you do when a stock or ETF falls below the 200-day moving average after you have bought it?
It is important to remember that we buy oversold markets because the odds are that those stocks are going to outperform in the short term. And the more oversold those markets become, the better that outperformance has tended to be.
Click here to read Larry Connors PowerRatings strategy article, How to Find the Best Stocks to Trade Every Day.
The simulated trades that support this outperformance from oversold stocks, especially the extremely oversold stocks that earn our highest PowerRatings of 8, 9 and 10, also include several instances over the years in which high PowerRatings stocks have dropped below the 200-day moving average after getting their upgrades to 8, 9 or 10. Many of those stocks turned around and made their short term reversals anyway.
And as it turns out, the stock that the e-mailer had asked about was an example of one of those instances. Ivanhoe Mines Ltd.
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PowerRating), which was first noted in our PowerRatings Daily Analysis column on April 15, broke down below its 200-day moving average after earning a PowerRating upgrade to 9. But for the next three consecutive days, buyers bid the stock higher, closing back above its April 15th close.
Not every high PowerRating stock will make this kind of move after falling below its 200-day moving average. Keeping your position sizes modest and within your risk tolerance levels is critical, and is what allows traders to trade high probability strategies like these without relying on stops.
Managing your trade is your decision as a trader. But if you find yourself feeling uncomfortable when your high PowerRating stock slips below the 200-day moving average, the problem may be less in the track record of high PowerRatings stocks and more in a position size that is uncomfortably large.
Our highest Short Term PowerRatings stocks have outperformed the average stock by a margin of nearly 17 to 1 after five days. Click here to start your free, 7-day trial to our Short Term PowerRatings!
David Penn is Editor in Chief at TradingMarkets.com.