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| Articles and Tutorials |
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| "Cheesecake Factory (CAKE)" |
| by Bob Eldridge |
| August 4, 2003 |
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We've all heard the phrase, "... fail to plan and you plan to fail" and perhaps we've even experienced an application or two in various parts of our lives. I learned a long time ago the importance of proper planning and preparation when trading in the stock market unless we want to leave our financial success up to chance and/or luck. I reinforce those principles in the Trade Lab everyday by publishing a trade plan at least 2 hours before each market open. I trade THAT plan, following the steps which I've laid out in advance.
Visualizing The Trade - The Strategy
Before anything actually happens, it first takes place in someone's head.
Your trading should be no different. You have to see the trade happening
before you place the first order if you are to bring the trade to the anticipated
profitable conclusion. Let's begin with the strategy, a crucial part of any trade.
This enables you to know HOW to react to whatever might happen while your money is
at risk, insuring that each action you take in the trade is well thought out and not
simply an emotional 'knee-jerk' reaction to the unexpected!
Which strategy you use depends upon conditions surrounding any specific trading situation.
Whose strategy you use depends upon your knowledge and experience. Each of us is capable of
devising our own trading strategies, or we're free to use those learned from others. Whatever
the source of that strategy, it must consist of a plan for every conceivable eventuality.
Let me use a recent trade plan as an example.
The strategy is found in the BACKGROUND section below. The Key Level Stock Reversal strategy
is designed to take advantage of anticipated changes of direction in stocks found in the Key Level
Stocks Section of the Dedicated Trader's Trading Center. This particular trade was on Cheesecake
Factory (CAKE) and was listed in the 'Stocks At Support' section. Obviously, if a stock is at support
we might expect it to reverse directions, bouncing, in effect. So, we would buy the stock, anticipating
being able to sell a short time later for a profit. How much of a move is an important aspect of keeping
our expectations reasonable, so knowing how much the stock moves on average each day is important. I
refer to this as Average Daily Range, or ADR. Here, CAKE has moved around $1.09 over the last week or so.
We'll build that into our plan.
Background: Today's trade is a Key Level Stock Reversal to the UP side. In Friday's trading, the stock
appeared to bounce at support, around $32. While not the PRIMARY motivation for this trade,
a positive move in the broader markets could easily help the stock price to move higher. Closing around $32.22,
CAKE stock has a 5 day ADR of around $1.09 so we will try to capture as much of that as we can. Be sure to
include stop losses and/or trailing stop losses as part of your position. Check "Getting Out" commentary below.
As always, we let the stock price CONFIRM our thoughts prior to trading.
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| The Trading Plan |
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SOURCE: The Dedicated Trader - Key Level Stock - Stocks At Support
PRIMARY OBJECTIVE: The reason for entering this trade is to
profit as the stock moves UP.
ALTERNATE OBJECTIVE: Preservation of capital should be high on our list! We
will accomplish that by waiting until the stock price CONFIRMS before entering
any trade and using stop losses and/or trailing stop losses to exit the trade.
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| Getting Into the Trade |
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There are only a few things a stock price can do when the market opens
and we must plan our reactions to each of these things BEFORE they happen! This insures
that we take the APPROPRIATE action, no matter what happens!
Getting In:
If the stock price CONFIRMS DOWN at the open, wait to enter the trade .
If the stock price CONFIRMS UP at the open, buy the stock.
If the stock GAPS UP, WAIT - Let it back fill then look for CONFIRMATION UP.
If the stock GAPS DOWN, let it CONFIRM UP as before.
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The stock opened, wiggling around before beginning a slide. From the outlined steps, we see that we're NOT to enter until the price confirms movement to the upside ... That didn't happen until around 10:40 am. We bought in around $31.79.
As you can see, we've planned our actions BEFORE the trade, which allowed us to avoid buying the stock prior to the opening price slide! Again, this keeps EMOTION out of our trading!
Get On The Path, Then DEFEND Yourself!
When trading, we have NO control over which way a stock moves. We THINK it will do this or do that, but there's no assurance one way or the other. So, our strategy should include some measure of defense in the event the stock moves against us! This is the SINGLE most frequent trading error for most new traders and can have devastating results if we ignore it!
Defense: Once you've entered the trade, immediately set a STOP LOSS at 1/2 the ADR ( around $..55) BELOW your entry.
Setting a 55 cent stop loss on a $31.79 entry price put our stop around $31.24. As you can see, the stock price wiggled around, but never went that low.
Managing the Trade: When you become profitable by 1/4 of the ADR (around $.27) or greater, replace the stop loss with a trailing stop, trailing by that SAME amount,.
This part of our plan dictated that we replace the stop loss with a 27 cent TRAILING stop to ride profits up. That occurs only when we're 27 cents profitable which occurred about noon. From this point on, if the stock price EVER slips by 27 cents or more, we're very likely to be stopped out! If this occurred immediately, we're out at breakeven!
Getting Out: If and when you are profitable and the stock has moved up, close to the amount of the ADR (say around $.75), tighten the trailing stop to around a dime. You can either allow the trailing stop to take you out of the trade or simply close the position to capture profit whenever you're satisfied. If this does not happen today and you feel inclined to remain long overnight, consider buying an at the money put for protection or placing a stop loss just below where the stock appears to be closing. This provides market risk protection for the next trading day's open.
The idea here is to allow profits to maximize, of course, without exposing those profits to an inordinate amount of risk. When the stock topped out an hour later around $32.18, I tightened my stop to around a dime being stopped out when the stock slipped to around $32.05.
The Results
By following a sound strategy, sticking to prudent trading rules and keeping our expectations within reason, MOST of our trades can work in our favor. From the Short Term Trade Record, here are the results we actually had with the CAKE trade:
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| Symbol |
Position |
Stock
Price
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Quantity |
Date
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Buy
Price
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Sold
Price
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Notes |
Strategy |
P/L |
| CAKE |
Stock |
$32.04 |
1000 |
7/29 |
7/29 |
$32.04 |
$32.18 |
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Key
Level Up |
$140 |
| CAKE |
Stock |
$31.79 |
1000 |
7/29 |
7/29 |
31.79 |
$31.98 |
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Key
Level Up |
$190 |
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| If you are not presently planning your trades to this extent, I would invite you to use the methods
we employ for maximizing profits and minimizing losses. Whether using my strategies or your own, each of your trades
should be the result of a carefully orchestrated plan, thoughtfully executed as conditions, not emotions dictate.
GOOD LUCK to each of you in the market! |
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Next: QLogic Corporation (QLGC)
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