How To Avoid Getting Shaken Out Of A Winning Stock Too Soon

Tom Vician CMT's picture

Tuesday, October 20, 2015 - 7:30am

by Tom Vician CMT

As the market continues to carve out what looks to be a bottom, I'd like to show you the power of my trend-following system, because it's during times like these that the next stock market leaders build their launch pads for huge uptrends. 

The Alpha Trader system is based on an indicator known as the Alpha Score. When pressure comes off the market, stocks showing high Alpha Scores are likely to be the first to take off. And we want to be ready to act immediately when the system signals a buy.

What makes the Alpha Score so special?

Simply put, it pinpoints winning stocks. 

The Alpha Score is a proprietary measure of fundamental and technical strength. I use it to rank all U.S. stocks based on two key drivers of big price trends. These two factors have shown up time and again at the beginning of huge price moves. 

Today, I want to show you the Alpha Trader system in action with a position we closed earlier this year in Southwest Airlines (NYSE: LUV) for a 54% gain.

LUV is far from our biggest winner. The Alpha Score has given buy signals for stocks that went on to gain 115%, 135%, even 242%. But LUV offers a perfect example of how the Alpha Trader system helps us ride profitable trends.

In May 2014, we issued a "buy" recommendation on LUV based largely on its Alpha Score of 170 out of a possible 200. As I said, the Alpha Score is based on a combination of two of the market's most effective technical and fundamental indicators. The higher the score, the more likely the stock is to break out and deliver big gains.

Note the series of higher highs and higher lows LUV was making before the buy recommendation. This is the definition of an uptrend and exactly what we what to see in a buy candidate.

This likely goes against everything you've been taught about investing, but the Alpha Score was not designed to find stocks that are bottoming. It was designed to spot stocks in a strong uptrend that are likely to go much higher. 

In LUV's case, shares soared 46% over the next four and a half months following our recommendation.

Even harder than knowing when to buy is knowing when to sell. It's easy to let emotion get the better of you, especially when a stock that has been a big winner starts to head south.

I'm sure plenty of you have kicked yourself for bailing on a stock during what in hindsight turned out to be just a minor speedbump on the road higher. 

Alpha Trader uses two quantitative sell rules that take the emotion out of the process.

First, we employ a stop-loss on every position. The stop is set 25% below the stock's six-month closing high. If it hits that level on a closing basis, we sell. That may seem like a wide stop, but it gives us plenty of breathing room to avoid getting shaken out of a position during a normal correction within a larger uptrend. 

The other sell signal is based on a proven and reliable technical indicator. When momentum begins to wane and this indicator triggers a "sell," we exit -- no questions asked.

Out exit rules are designed to tell us when the longer-term trend has changed while still giving uptrends room to vacillate. Cutting losses short and riding winning trades to maximize profits are the keys to Alpha Trader's success. 

Here's how it played out with Southwest Airlines…

Shortly after hitting a high in September 2014, LUV sold off sharply as the Ebola scare had investors dumping shares of everything, especially airline stocks. 

LUV corrected with the rest of the market, even breaking below its 50-day average, but neither of our sell rules was triggered. And that's a good thing, because once investors stopped panicking, LUV resumed its longer-term uptrend.

When our system finally triggered a sell in May 2015, investors cashed out with a 54% return. As I mentioned, this is far from our biggest winner, but we did beat the market by 41 percentage points while we held shares. 

Following our sell recommendation, LUV corrected even further before trading in a choppy sideways pattern for months. In fact, it has only recently regained its May highs

As trend followers, we never enter at the bottom nor sell at the top. Our goal is to capture profits from the middle chunk -- the meat of the move if you will.

LUV is an excellent example of the Alpha Trader system in action. 

If you'd like to learn more about the Alpha Trader system, I urge you to take a minute to watch this presentation we've put together. It reveals how the Alpha Score works and the name and ticker symbol of a top-rated stock flashing "buy." This presentation is coming down soon. Follow this link to access it.

This article was originally published on ProfitableTrading.com: How to Avoid Getting Shaken Out Of A Winning Stock Too Soon

Tom Vician CMT does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.