Pascal
01-31-2015, 07:54 AM
I have been asked to post one example of how to use the Breakout Calculator to analyse the potential of a trade. I select the company POT, because they issued good - in line - earnings two days ago. The company also offers 3.9% dividends, which is interesting in the current environment.
The first step is to look at the price Figure and decide what is the most probable trade to test.
We can see below that POT is in an uptrend. The 50MA has been a good guide for both the up and the downtrend.
We can see that the most probable trade is a continuation of the actual uptrend, especially since earnings were in line. Our first question is to define the start of the current trend: is it October 2014 or August 2013? I prefer using August 2013, because a longer term period offers more data, including the data of the downtrend (shown with the red arrow.)
28174
I will also consider all the other data available on the EV web site regarding POT. However, the Breakout Calculator works completely independently from the other EV tools.
We can see below that POT offers an interesting Pyramid:
- The stock has a good LER and a very low supply. This means that funds are buying and that because the Supply level is very low, the probability for a pull-back that could be the start of a downtrend is also very low.
- The fertilizer sector is in a long mode and has a Relative Strength that is very high (RS is rated between 0 and 100)
- The whole market however is "iffy" here. That is the weak point of the current long trade: we could eventually experience a big market crash that will take everything down, including POT. However, the market is slightly oversold here and might also bounce. So, nobody really knows.
28177
As a reference, here is the Supply Figure for POT. This Figure tells us that a pull-back to 35.5 would provide the lowest selling pressure... If we can get to that point of course!!
28186
But let's come back to the Breakout Calculator (BC.) (see the icon description below.)
28192
The first step (after having downloaded the data) is to find the envelope size for the period of analysis. I take 300 days, with a "PB" as type of trade (Pullback.) I then use the "envelope" icon to get the envelope size.
28179
We can see below that the 2.4% envelope captures 90% of all the price bars for the analysis period. This means that a stop set outside of the envelope has only a 5% probability to be hit. That is the main use of the envelope: to set the stop levels for the trade. The envelope can also be used to detect overbought/oversold levels. Hence, when the current price is outside of the envelope, it is wiser to test the "OB" or "OS" trades instead of the Pullback trade type.
28170
Let's now zoom on the last months. We can see that in the past days, POT has been bouncing of the 35.5 support level. As you remember, this is exactly the lowest supply level for the stock. This is not by chance of course. So, it seems interesting to test an entry slightly lower than the 5MA, maybe down to the 35.5 level.
28172
So, we leave the two stop cells empty and click on the main calculation icon and get the results below.
We can see below - in Pink - that the stop cells have been filled. The BC will set the stop level just outside of the envelope, with a minimum of 2.5%. Always make sure that your stop is bigger than the 20D ATR (Average True Range.) This ATR measures the daily volatility for the past 20 days. If your stop is lower than the ATR, it will have great probability to be hit.
We can see below that we are testing a pullback to -1% ($35.86.) There is only a 7.67% probability to reach that level on Monday though, but the returns seem interesting.
As a reminder:
The R/R ratio must be higher than 1. ALWAYS! I prefer a R/R ratio higher than 2 (meaning that I have twice the probability to earn than to lose money on that trade)
The average profit per trade is the expected profit. It should be higher than 1% for a 5 days period. This would be about a 44% annual return on the trade.
The Strategy Efficiency is a comparison of what non-overlapping trades using this strategy would have produced for the past 300 days, compared to a buy and hold strategy. This Strategy Efficiency should be higher than 1.
28171
We could also test a 10 days holding period instead of 5 days. We can see that the profit per trade improves. Indeed, this means that we are taking advantage of the trend by staying in the trend. This also means that even if I base my entry on a 5 days return probability, after 5 days, I can retest the trade and see what the probability is for staying longer. The holding period is not a decision that I need to take at the time of entering the trade.
28173
As a matter of fact, if I use the Breakout Calculator Plus (which includes the sensitivity analysis,) then I can see that the ideal holding period is about 17 days.
28176
Now, let's come back to our test and try buying a pullback to the 5MA (and not 1% below the 5MA).
Let's leave the stop levels empty again!
28182
The results are shown below. We can see that the returns are weaker. This tells us that it is better to wait for a deeper pull-back.
28178
A sensitivity analysis shows that we indeed should wait for pullbacks that are at least -0.5% below the 5MA.
28185
We could also test a breakout such as the one that occurred in November.
28183
Since breakouts are not numerous, it is better to use longer analysis period of for example 500 days.
We can see below that besides 500 days, we need to indicate "BO" as trade type and empty the stop cells.
28189
Results are shown below. They test a breakout above $37.25.
We can see that the stops are much too wide for a breakout trade. Indeed, if we expect a breakout to occur, then we should not wait for the price to fall below the envelope before deciding that the breakout is a failure. Usually, a reversal below the 5MA would be enough to cancel the trade.
28184
Hence, let's change the stop to just below the 5MA.
28180
Results look better, but still not very impressive
28181
Let's now try a Breakout on Volume (BOV type of trade), using $36 as stop level.
28190
We can see below that we found 21 cases for such breakouts, but that in general, results were not good at all.
This tells us that POT is not a stock that reacts well on breakouts. It is not a "hot" stock, that is a stock whose new momentum will attract new buyers (FB, TSLA, etc.) It is a stable stock with a very stable business model and an expected yield. This is a stock that will trade on a value base P/E and yield analysis. Hence, breakouts will attract sellers who will rotate to less expensive stocks.
28191
We can see below that even stronger breakouts do not offer good opportunities.
28188
We can also see below that keeping breakout trades for more days does not improve the general picture of the trade.
28175
Conclusions:
The best is to buy POT on pullbacks below the 5MA and keep the trade for 15 days.
The first step is to look at the price Figure and decide what is the most probable trade to test.
We can see below that POT is in an uptrend. The 50MA has been a good guide for both the up and the downtrend.
We can see that the most probable trade is a continuation of the actual uptrend, especially since earnings were in line. Our first question is to define the start of the current trend: is it October 2014 or August 2013? I prefer using August 2013, because a longer term period offers more data, including the data of the downtrend (shown with the red arrow.)
28174
I will also consider all the other data available on the EV web site regarding POT. However, the Breakout Calculator works completely independently from the other EV tools.
We can see below that POT offers an interesting Pyramid:
- The stock has a good LER and a very low supply. This means that funds are buying and that because the Supply level is very low, the probability for a pull-back that could be the start of a downtrend is also very low.
- The fertilizer sector is in a long mode and has a Relative Strength that is very high (RS is rated between 0 and 100)
- The whole market however is "iffy" here. That is the weak point of the current long trade: we could eventually experience a big market crash that will take everything down, including POT. However, the market is slightly oversold here and might also bounce. So, nobody really knows.
28177
As a reference, here is the Supply Figure for POT. This Figure tells us that a pull-back to 35.5 would provide the lowest selling pressure... If we can get to that point of course!!
28186
But let's come back to the Breakout Calculator (BC.) (see the icon description below.)
28192
The first step (after having downloaded the data) is to find the envelope size for the period of analysis. I take 300 days, with a "PB" as type of trade (Pullback.) I then use the "envelope" icon to get the envelope size.
28179
We can see below that the 2.4% envelope captures 90% of all the price bars for the analysis period. This means that a stop set outside of the envelope has only a 5% probability to be hit. That is the main use of the envelope: to set the stop levels for the trade. The envelope can also be used to detect overbought/oversold levels. Hence, when the current price is outside of the envelope, it is wiser to test the "OB" or "OS" trades instead of the Pullback trade type.
28170
Let's now zoom on the last months. We can see that in the past days, POT has been bouncing of the 35.5 support level. As you remember, this is exactly the lowest supply level for the stock. This is not by chance of course. So, it seems interesting to test an entry slightly lower than the 5MA, maybe down to the 35.5 level.
28172
So, we leave the two stop cells empty and click on the main calculation icon and get the results below.
We can see below - in Pink - that the stop cells have been filled. The BC will set the stop level just outside of the envelope, with a minimum of 2.5%. Always make sure that your stop is bigger than the 20D ATR (Average True Range.) This ATR measures the daily volatility for the past 20 days. If your stop is lower than the ATR, it will have great probability to be hit.
We can see below that we are testing a pullback to -1% ($35.86.) There is only a 7.67% probability to reach that level on Monday though, but the returns seem interesting.
As a reminder:
The R/R ratio must be higher than 1. ALWAYS! I prefer a R/R ratio higher than 2 (meaning that I have twice the probability to earn than to lose money on that trade)
The average profit per trade is the expected profit. It should be higher than 1% for a 5 days period. This would be about a 44% annual return on the trade.
The Strategy Efficiency is a comparison of what non-overlapping trades using this strategy would have produced for the past 300 days, compared to a buy and hold strategy. This Strategy Efficiency should be higher than 1.
28171
We could also test a 10 days holding period instead of 5 days. We can see that the profit per trade improves. Indeed, this means that we are taking advantage of the trend by staying in the trend. This also means that even if I base my entry on a 5 days return probability, after 5 days, I can retest the trade and see what the probability is for staying longer. The holding period is not a decision that I need to take at the time of entering the trade.
28173
As a matter of fact, if I use the Breakout Calculator Plus (which includes the sensitivity analysis,) then I can see that the ideal holding period is about 17 days.
28176
Now, let's come back to our test and try buying a pullback to the 5MA (and not 1% below the 5MA).
Let's leave the stop levels empty again!
28182
The results are shown below. We can see that the returns are weaker. This tells us that it is better to wait for a deeper pull-back.
28178
A sensitivity analysis shows that we indeed should wait for pullbacks that are at least -0.5% below the 5MA.
28185
We could also test a breakout such as the one that occurred in November.
28183
Since breakouts are not numerous, it is better to use longer analysis period of for example 500 days.
We can see below that besides 500 days, we need to indicate "BO" as trade type and empty the stop cells.
28189
Results are shown below. They test a breakout above $37.25.
We can see that the stops are much too wide for a breakout trade. Indeed, if we expect a breakout to occur, then we should not wait for the price to fall below the envelope before deciding that the breakout is a failure. Usually, a reversal below the 5MA would be enough to cancel the trade.
28184
Hence, let's change the stop to just below the 5MA.
28180
Results look better, but still not very impressive
28181
Let's now try a Breakout on Volume (BOV type of trade), using $36 as stop level.
28190
We can see below that we found 21 cases for such breakouts, but that in general, results were not good at all.
This tells us that POT is not a stock that reacts well on breakouts. It is not a "hot" stock, that is a stock whose new momentum will attract new buyers (FB, TSLA, etc.) It is a stable stock with a very stable business model and an expected yield. This is a stock that will trade on a value base P/E and yield analysis. Hence, breakouts will attract sellers who will rotate to less expensive stocks.
28191
We can see below that even stronger breakouts do not offer good opportunities.
28188
We can also see below that keeping breakout trades for more days does not improve the general picture of the trade.
28175
Conclusions:
The best is to buy POT on pullbacks below the 5MA and keep the trade for 15 days.