I’ve revised my rules for trading shares. Here’s the new version, and it can be accessed at any time under the Trading Rules tab at the top of each page.

Lower Risk: Shares

Shares are considered to be lower risk than options because they can be traded without leverage and are generally have lower volatility.

On the other other hand, options positions can be positioned in a way that limits the possible loss if the price moves against the trader. Shares can drop to zero. I’ve had it happen.

In trading shares I use the same mix of techniques that I use in trading options in connection with earnings announcements (see the “Earnings Plays” section, above).

In broad terms, I select candidates using a broad indicator of some sort, based on something other than the chart. To time my entry, I use a narrower chart-based indicator — technical analysis — to guide my opening of the position. To time my exit, I use the broad indicator. For entries and exits, I confirm the indicators through Elliott wave analysis of the chart.

My preferences are to use analyst opinions, tracked by Zacks Research, for the broad indicator. I select trade candidates from stocks that have a bullish rank, a score of 1 or 2 on the Zacks analysis. I also give preference to stocks awarded a high momentum score — A or B — under the Zacks method.

For the narrower chart-based indicator, I use the Fisher Transform. It’s not widely available — I’ve seen it on one of the brokerage platforms I use, TDAmeritrade. But any technical indicator can be used. Where the Fisher is unavailable, I tend to use the RSI.

Here are my trading rules:

• Buy long shares
  • Zacks score is 1 or 2
  • Zacks moment indicator is A or B
  • The technical indicator (Fisher Transform or RSI) has just switched to uptrending from below the base line (0 on the Fisher and 30 on the RSI).
• Place a trailing stop loss of 20%
  • If the technical indicator gives a downtrending signal
  • If Zacks score becomes greater than 2.

The best tool that shares offer to mitigate that risk is the stop-loss; setting a price at which shares will be sold if the market price reaches that level.

I use a trailing-stop loss. For long shares, if I set a, say, 3% stop-loss, and the price of the shares rises, then the stop-loss will also rise, remaining 3% below the peak price.

I will use 3% occasionally as a very short-term insurance to limit loss, but my normal practice is to give shares room to maneuver. For that purpose, I use a 20% trailing stop. I’ve based based choice on three research papers:

Han, Yufeng and Zhou, Guofu and Zhu, Yingzi, Taming Momentum Crashes: A Simple Stop-Loss Strategy (September 24, 2016). Available at SSRN: https://ssrn.com/abstract=2407199 or http://dx.doi.org/10.2139/ssrn.2407199

Yusupov, Garib and Shorrason, Bergsveinn, Performance of Stop-Loss Rules vs. Buy-and-Hold Strategy (2009). Available at Lund University: https://www.lunduniversity.lu.se/lup/publication/1474565

Kaminski, Kathryn and Lo, Andrew W., When Do Stop-Loss Rules Stop Losses? (January 3, 2007). EFA 2007 Ljubljana Meetings Paper. Available at SSRN: https://ssrn.com/abstract=968338 or http://dx.doi.org/10.2139/ssrn.968338

By Tim Bovee, Portland, Oregon, March 31, 2022

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.

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Based on a work at www.timbovee.com.