My zone trading strategy

There are limitless possible trading strategies, many based on technical analysis, many not.

Whilst one can adapt the strategies of others, the challenge is to design one oneself, tailored to our own needs. By way of illustration, I detail my own experience.

It has taken several years to work out this risk-averse system that conserves my capital as a retiree whilst delivering reliable income on which to live.

Objective

I have called my preferred, capital preserving, equities investment strategy “zone trading” because it highlights my objective to find and trade price movements that can transcend the usual historical zones of support and resistance, to new highs.

In the past I have just included one or two stocks with promising growth potential in my portfolio, but have then had to wait patiently for a favourable market response.

My current strategy seeks to reduce the waiting period by focusing on stocks which have already started to surge.

Selection methodology – narrowing the field

The problem is that there are so many stocks that create buying excitement with promising upwards momentum, only for it to peter-out and the share-price to then head lower. It is a truism that upward unidirectional impulsive movement sequences are always followed by correctional movements lower.

Volatile speculative stocks, fodder for day and short-term traders, usually trade thus. Longer-term investors delay their entry until there is technical confirmation of ongoing buying support.

A helpful adjunctive consideration for me is to take into account relevant and reliable news releases likely to impact on company profit. This does not mean listening indiscriminately to all the daily news chatter that floods the market, but only to take into account issues of importance for the stocks I hold or am interested in. My source of information is the ASX website.

Most technical analysts focus only on the chart appearances determinedly avoiding the distraction of news and comment. I am less categorical because some information, such as the profit upgrades and warnings, may be highly significant and signal a potential for re-rating of the stock.

Another common event to note is the occurrence of capital raisings. On one hand they may provide an opportunity to invest at a discount to the market. On the other hand they are often a harbinger of ongoing price weakness. This applies particularly to venture stocks especially when they transition to production and need more capital.

Selection methodology – Technical criteria.

Because it is not possible to accurately predict how the market will respond to any one news bulletin, it is best to defer entry (or exit) until after important technical milestones have been passed. This means daily monitoring of the emerging price action for direction, strength and likely durability.

What one should look for depends on whether the share-price has been falling, is flat in a trading range, or is already trending higher.

  1. If the share-price has been trending lower, the objective would be to monitor for a change in trend before investing.
  2. If it is in a trading range, the criterion for entry/exit would be a break-out above/below previous support/resistance.
  3. If the stock has already been trending higher, but has been paused for a time, one would look for a resumption of trending with an increase in the numbers and eagerness of buyers. If however the price was actively trending already, one would be further encouraged if the slope of the trend increased.

Exit methodology

Exiting positions is usually more problematic than entry.

This is because the market is notoriously unpredictable, and positions may need to be sacrificed at a loss to avoid further losses or the risk of them.

Furthermore retirement funds need to be regularly tapped for income regardless of the state of the market. I endeavour to then sell a sufficient parcel of the worst performing stock(s) in my portfolio to meet my requirement.

Retirees who are no longer earning are in the unenviable position of needing to sell stock before they can take up attractive buying opportunities in the market. In this situation one must compare the relative prospects for gain of the proposed stock acquisition against that of the stock which must be relinquished. This is likely to be a matter of opinion, and it is easy to make the wrong choice.

The biggest dilemma when selling however is to judge when the reward of further price gains is out-balanced by the risk of a correction which will erode present profit gains.

Most stocks that are trending higher will from time to time pause from trending by entering a trading range. It is impossible to know whether such side-ways movement is a preamble to a downturn, or whether the stock will rally and continue its upward trend.

One valuable option for management is to take profit by part-selling down one’s holding. Another option is a full sale to enter a new position in a stock that may have better prospects.

When it comes to stop/loss selling there are a raft of technical indicators which can be employed for the purpose, varying in sensitivity. If too sensitive, one is likely to have been tricked into selling too soon, with the stock rebounding quickly into positive territory. If insufficiently sensitive, one is likely to have more profit eroded before exiting.

I have found the concept of historical trading zones to be helpful as an exiting tool. I quit my position when the share-price declines into a lower trading zone as the probability of a quick rebound to the higher level is low. Even if further falls do not occur, the share price will probably stagnate in this zone until further news guidance emerges.

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