The Position Trader
Position trading is a popular trading style used by stock traders which seeks to capture a larger portion of the trend than what swing trading does.
The time frame for position trading is much longer than that for swing trading which makes this style of trading suitable for those with limited spare time. The time required for trade selection and trade management is considerably reduced compared to other trading styles such as day trading and swing trading.
Position traders basically look to capture as much of an intermediate-term trend as possible. This means the position trader holds their position through the short-term corrections rather than exiting on these corrections as the swing trader does. A position trade can be thought of as a sequence of rallies and pullbacks and the position trader will hold their position until this trend appears to be completed. While the swing trader is only after one swing within an intermediate-term trend, the position trader generally seeks to capture most of the intermediate-term trend.
The term 'position' simply means to take a position in a stock and ride the trend for as long as it continues before being stopped out.
Position traders tend to spend most of their time on the long side, but they will short sell during bearish market conditions. Like most other styles of trading, position trading is more profitable when traded in the direction of the market. Bull markets are considerably longer than bear markets and this explains why position traders spent most of their time trading long.
Position trading concepts can be applied to any time frame such as intraday, daily, weekly or even monthly. Charts displaying daily bars are used by end-of-day traders seeking the intermediate-term trends and charts with 5 minute bars are used by day traders to capture the intraday trends. Weekly bars are not as popular but they are quite useful for stock traders and even stock investors who are seeking to participate in a long-term trend. Monthly bars are mostly used to get a long-term prospective of the stock rather than for trading purposes.
An example of a position trade using daily bars is shown in Chart 1. The entry is taken from a breakout from a Wedge chart pattern.
Chart 1. Position Trade Entry - Long position
Position traders use technical analysis techniques such as chart patterns and chart indicators to evaluate their proposed trades and to manage any open positions.
Some position traders favor chart patterns and use them almost exclusively while only using some basic chart indicators for their analysis, while other position traders prefer to use chart indicators almost exclusively. Some position traders will use all of the technical analysis tools available to them. Which technical analysis tools to use is a personal preference and there is no right or wrong approach.
The series of articles on Position Trading Tactics gives numerous examples of position trades taken from the magazine issues.
Generally position traders who base their trades on a chart pattern will use the low of that pattern to place their initial stop-loss (which is usually a small distance below that low for a long side trade). Position traders who base their entry on a signal from a chart indicator tend to use the chart indicator to signal an exit rather than placing an initial stop-loss.
Most position traders who based their entry on a chart pattern will use some form of trailing stop-loss. The trailing stop-loss generally needs to remain some distance below the current price bars so as to give the stock sufficient room to pullback otherwise the position trader will be constantly stopped out on a good uptrend. Some common methods of managing a trade with a stop-loss are:
Common stop-loss methods:
- Moving Average Cross Over: With this method, the trader plots two moving averages on their chart and an exit signal is given when the two moving averages cross over each other. The moving averages can be of any length. A popular setup is to use a 10-day for the shorter moving average and a 30-day for the longer moving average. It's also common to use Exponential moving averages (EMA) rather than simple moving averages.
- Pullback Low: This method gives a lot of room for the stock to move and simply uses the relative lows of an uptrend as the trailing stop-loss. When the stock makes a new pullback and then rallies, the low of this higher pullback becomes the new value for the trailing stop-loss. Using a 10-day simple moving average helps to indentify the pullback lows. An exit signal is given when the stock closes below the trailing stop-loss.
- Parabolic SAR: This method uses the chart indicator to determine the trailing stop-loss level. The parabolic SAR variables can be set so that it gives the stock some room to move and is quite an effective and easy trailing stop-loss tool to use. An exit signal is given when the SAR indicator plots its Dot on top of the Bar instead of the bottom.
The Moving Average Cross Over stop method for the Amazon.com trade example in Chart 1. is shown below in Chart 2.
Chart 2. Moving Average Cross Over stop method
The Pullback Low stop method for the Amazon.com trade example in Chart 1. is shown below in Chart 3. (Note that in this example the stop has not triggered).
Chart 3. Pullback Low stop method
The Parabolic SAR stop method for the Amazon.com trade example in Chart 1. is shown below in Chart 4.
Chart 4. SAR Indicator stop method
Some traders will ride the trend as far as they can using a stop method while others will exit their position at a chart pattern price target. When exiting at a price target, some position traders prefer not to use a trailing stop-loss as this can prematurely exit their position before the price target is reached.
End-of-day position traders base their trading decisions on the daily charts. Once an entry is triggered on the daily chart by either chart pattern or a chart indicator, the position trader places an entry order to be executed the next trading day. Some position traders simply place a market order which will be executed as soon as the market opens. The disadvantage with placing a market open order is that the Bid-Ask spread at the open is usually extremely wide and gives the position trader a poor entry price.
The market order can be placed with a time delay so the order is executed at a set time after the market opens. Position traders who use time delay orders tend to set the time to around an hour after the market opens.
The trade exit for a stock that reaches its price target can be triggered intraday or end-of-day. If the position trader places a limit sell order for a long side trade, the sell order will be filled during the trading day when the stock price reaches the limit order price. If the position trader instead monitors the daily closing prices and waits for the stock to close above the price target, a market sell order needs to be placed for execution the following day (like the market buy order used for the entry).
Generally if a price target is used it is easier to place a limit sell order and this will ensure that the target price is received. With the closing price method, the price obtained could be higher or lower and the stock may not even close above the target price even if the stock trades above it during the day.
For position traders who are using a trailing stop-loss they have the same two options for placing their stop-loss sell order - an intraday trigger or an end-of-day trigger. If the position trader places a limit sell order, this order will fill during the trading day whenever the stock price trades to that limit price. The disadvantage with this method is that the stock will frequently trade below the stop-loss level but will close above it. This means that the position trader will be stopped out more frequently. With the end-of-day method, the position trader monitors the daily chart and an exit is triggered when the stock actually closes below the stop-loss level. To exit the trade, the position trader places a market sell order to be executed the following day. This order can be time delayed so that it executes after the market has opened.
Position trading on the short side is essentially the inverse of trading on the long side. The first consideration is that the position trader requires a trading account which allows short selling. The risks are higher with position trading on the short side.
Traders need to be aware that there are additional
risks associated with short selling
Position trading in general is a moderate risk trading strategy providing that all losing positions are exited at their stop-loss levels. The risks with position trading increases when losing positions are not exited and instead held with the hope that prices will return to their entry price so that the position trader can exit at breakeven.
Most position traders prefer not to short sell during bull markets since most stocks are in an uptrend and position trading works best when trading with the broad market sentiment. Bear markets do provide opportunities for short selling since the broad market is heading downwards, but caution needs to be exercised by the position trader since bear markets are relatively brief in duration compared to bull markets.
Long-Term Position Trading
The weekly bar chart provides the position trader with a method of participating in the long-term trend. This style of trading is essentially passive and involves the least amount of time in trade selection and position monitoring. Position traders who do not have the time to actively trade tend to prefer the long time frame of weekly charts.
Stock investors are also attracted to weekly charts as it provides a long-term view of their investments. Some stock investors participate in short-term investments with the view of riding the uptrend of a stock and exiting when the uptrend ceases. These stock investors are active investors rather than buy and hold investors and will included fundamental analysis and technical analysis into their decision making process. This combination of fundamental analysis and technical analysis with a weekly bar chart is sometimes referred to as technical investing or speculative trading.
These considerations are in addition to charting analysis
There are several technical considerations which impact on position traders. These can provide the position trader with additional information that is not found by merely examining the stock's price chart. By being aware of these considerations the position trader can make an informed decision as whether to enter a proposed trade or pass it up for a better opportunity.
An industry group can be tracked with an index in the same manner as tracking the broad market with an index such as the S&P 500. Basically all industries consist of one or a couple of large companies and the rest tend to be smaller companies.
As a general rule with industry indices, if the index is in a long-term uptrend it is primarily due to one or two large stocks that are in an uptrend. Essentially the remaining smaller stocks tend to follow sooner or later. The one or two large stocks are known as the Leaders and the smaller stocks are known as the Laggards. The following three chart examples illustrates this.
Chart 1, below shows the industry leader for the health care services industry.
Chart 1. Large-cap Industry Leader
Chart 2. below shows a Mid-cap stock that is following the industry leader.
Chart 2. Mid-cap stock following the Industry Leader
Chart 3. below shows a Small-cap stock that is influenced by the industry leader.
Chart 3. Small-cap influenced by the Industry Leader
In Chart 3, above the Small-cap stock is still responding to most of the rallies set by industry leader.
This group behavior is a common characteristic of industry groups. When the Leader is in a long-term uptrend, a small stock in the group which is performing poorly on a fundamental basis that is in a long-term down trend has a tendency to turn into an uptrend and follow the Leader even though its fundamentals do not support this. The uptrend is probably intermediate-term but can even become a long-term uptrend.
This Leader and Laggard phenomenon comes about due to institutional investors such as mutual funds, banks and insurance companies which generally favor buying stock in large companies. These institutional investors with their significant research resources are typically the first to discover the changing trends of an industry. Their large buying pressure drives up the prices of the large stocks in an industry group. The smaller stocks in the industry tend to be bought by speculators and retail investors who usually discover these new industry trends later on. When they start buying then this provides the demand to drive up the smaller stocks. Sooner or later the smaller stocks tend to follow the trend of the Leaders.
Another useful characteristic with industry groups is that the intermediate-term trends frequently coincide with the stocks from an industry group. The intermediate-term trends set by the Leaders tend to be followed by the laggards even if the long-terms are in different directions. This means if a Leader is in a long-term uptrend and the Laggard is in a long-term downtrend, when the Leader rallies the Laggard rallies and when the Leader pulls back the Laggard sells-off.
The reason the Laggards follow the Leaders is that the smaller stocks in the industry tend to be bought by speculator traders and retail investors who observe that the large stocks are rallying. This rallying motivates them to also buy, however they frequently buy the smaller stocks which causes these to also rally.
Some position traders use these industry group characteristics to their advantage. For example, if a Leader is rallying, the position trader looks for a Lagging stock that formed a chart pattern and has just broken out. Since the Leader is already rallying it increases the likelihood that the Laggard will follow with the rally.
The stock market cycles through bull and bear markets. These are the long-term market trends, but each bull market and each bear market have a sequence of alternating intermediate-term uptrends and intermediate-term downtrends. The intermediate-term uptrends are often referred to as market rallies and the intermediate-term downtrends are often referred to as market corrections.
Thus a bull market is characterized by a market rally followed by a market correction which is followed by a market rally and this alternating trend behavior continues for as long as the bull market lasts.
Position trading is the most profitable when the stock is trending in the same direction as the market. This means a long side trade within a bull market is more profitable when the market is rallying rather than pulling back with a market correction.
Chart 4. below shows the S&P 500 with two moving averages to highlight the market rallies and pullbacks.
Chart 4. Market Rallies and Pullbacks
Referring to Chart 4. above, the 10-day simple moving average (red line) does a good job of highlighting the short-term market rallies and market pullbacks. The 50-day simple moving average (blue line) shows the general directions of the intermediate-term trends.
Fortunately in bull markets, market pullbacks are generally shorter in duration than market rallies so if the position trader remains trading on the long-side in a bull market they will generally remain net profitable. Some position traders are tempted to short sell during market pullbacks in a bull market, however this causes problems since the duration is generally short and when the market rally resumes it leaves the short seller having to chase the stock up to cover their shorts.
The stock market is inherently bullish. After all nobody invests with the intention of their investments going down in value. Position traders who remain on the long side during bull markets fair much better than those who attempt to short sell through market pullbacks.
The natural long-term direction for
the stock market is upwards
Short selling is best reserved for bear markets since their short positions will follow through more readily in a general pessimistic environment. Also position traders who trade on the long side with market rallies in a bear market have the same problem as shorting market corrections in bull markets.
The Short Interest is the number of shares sold short divided by the shares outstanding and expressed as a percentage. The short sold shares are shares that are currently borrowed and exclude any shares that have been covered. Not all stocks can be sold short and generally the small and illiquid stocks cannot be short sold.
The short interest is a useful indication of future buying demand. This is because every share that is short sold must be covered sooner or later and the only way for a short seller to exit their position is to buy stock, since they must hand stock back to the investor from which they borrowed the stock from in the first place.
The difference between buying a stock and short selling a stock is that when buying stock an investor can always keep the stock indefinitely since they own it, but when short selling stock the short seller is borrowing someone else's stock to sell and they must eventually hand stock back which means they must buy the stock.
Generally the short positions are held for shorter durations than that for long positions. Thus a stock with a high short interest has a proportionally higher buying demand due to the short positions that need to be covered.
Stocks that are in an intermediate-term uptrend with a high short interest are desirable for position trading due to the potential additional buying from short sellers covering their positions. This is because with an uptrend the short seller is losing money and a continuing uptrend will keep triggering their stop-loss levels.
With a downtrend investors can hold their positions and do not need to sell (also value investors add to their positions where appropriate) which limits the amount of downside move. However with an uptrend short sellers cannot just hold their positions since most short sellers are actually stock traders rather than investors. That is they have a short-tem view with short-term profits and must sell at their stops. They do not hold their positions like long side investors do. This is partly why stocks can go up 500% or even 1,000% but can go down no more than 100%.
Stocks with a high short interest provide more upside potential when the stock is in a strong uptrend. When a stock is down trending it only reinforces the short seller's perception that the down trend will continue, however with an uptrend that continues upwards the short seller is probably thinking they made a mistake shorting this stock.
The upside potential from a stock with a high short interest tends to increase with a reduction in liquidity. This is because the short sellers must exit at their stop-loss and the fewer shares there are for sale then the more the short sellers have to bid to buy those shares to cover their position.
These may affect the traders position
There are several fundamental considerations which impact on position traders. These typically cause position traders to be stopped out of their positions, often with a loss (especially if they have just entered their position). By being aware of these the position trader can make an informed decision as whether to enter a proposed trade or pass it up for a better opportunity.
The position trader should be aware of the Tax-loss selling which typically occurs at the end of the fiscal year, especially the last couple of weeks in December for stocks with financial years ending in December. This tax-loss selling can cause problems with the chart pattern setups for position traders.
Stocks that have been trending down for most of the year will have accumulated a significant number of stock investors and even stock traders who held onto their losing positions. The end of the fiscal year presents an opportunity to rid themselves of these losers. The enticement of tax deductions is a strong motivator as they can use these to offset any capital gains they have.
This downward pressure on these losing stocks may generate chart pattern setups on the short side. The problem with these setups is that when the New Year starts all of the tax-loss selling pressure is removed and any position trader that takes a short position will likely be stopped out of their short trade at a loss.
The other consideration is that with stocks that have spent most of the year in an uptrend. The stock investors who bought the losing stocks are by now regretting that they did not buy these winners. So when they sell their losing stocks the lure of these winning stocks is just too great. They use the funds received from selling their losing stocks and buy the winning stocks.
The problem here is that any chart pattern setups that form for a long side trade are temporally being driven from the buying pressure of the tax-loss sellers who are rotating their funds. Once the New Year starts this buying pressure usually ceases and the stock will probably be the subject of profit taking. Thus any long positions taken from a chart pattern by the position trader will probably be stopped out.
Quarterly Earnings Season
The quarterly earnings season poses some issues that the position trader should be aware of as this can interfere with their trading.
The first consideration is that companies often warn the market if their earnings are likely to disappoint the market, which generally means it will be a poor result. These earnings warnings are usually made several weeks before the earnings announcement and are usually made when the market is closed. The typical outcome is that the market reacts with a gap down when the market opens the next trading day.
The problem this poses for position traders who recently entered a long position is that the gap down will typically be some distance below their stop-loss level which results in a larger than expected loss.
The second consideration is that if a stock rallies before the earnings are announced, there is a high expectation by the market that the earnings results will be good. If the reported earnings disappoint, then the stock is ripe for a sell-off.
A position trader who enters a long side trade just before an earnings announcement in a rallying stock has a good chance of being stopped out, probably at a loss. Generally to keep the rally going after the earnings is announced, the reported earnings would have to be exceptional. Merely meeting the forecast earnings is insufficient since the market is probably expecting the reported earnings to exceed or at least meet a whisper number.
The third issue position traders' face is that the market can be quite volatile during the earnings season. This can cause perfectly good trades to be stopped out even though the trade then continues in its original direction. Merely having a large blue-chip report an earnings result that was not expected by the market can dramatically move the market on that day. The problem here is that the position trader's stock can get caught up in this temporary move which can stop them out of their position.
The fourth issue is that when all the large blue-chips have reported, the market may well trend in the direction of those results. Thus if the market was expecting good earnings results but did not receive them, then the market will probably sell-off. The problem this poses for the position trader who just entered a long position is that their stock will probably also sell-off along with the market and stop them out with a loss.
All position traders and indeed all stock traders need to be aware of the Ex-dividend date and the dividend payment. Even if the stock does not normally pay a dividend, it may pay a special dividend. These special dividends are a once off payment which is usually quite large.
Stocks that pay higher dividend yields (typically above 2%) often lead to a quick rally in the week or two before the Ex-dividend date. This rally is known as the Dividend rally. Once the Ex-dividend date is reached it's common for the rally to fade and will often cause the stock price to return back to where it was prior to the dividend rally.
An example of an ex-dividend rally is shown below in Chart 1.
Chart 1. Dividend Rally
Another common phenomenon with the Ex-dividend date is the Ex-dividend gap down. Basically any dividend payment made will lead to the stock gapping down by approximately that amount on the Ex-dividend day's open. The problem this causes position traders is that they may well be stopped out of a perfectly good trade simply because of the dividend. The position trader will actually receive the dividend payment since they held the stock before the Ex-dividend date.
The position trader might consider adjusting their stop-loss down by the dividend amount, but this leads to another issue and that is once the dividend is paid the stock may trade back down for the next week or two.
The dividend poses another issue for short sellers who borrow stock to short sell. They are required to pay the dividend amount to the investor from whom they borrowed the stock from. While the Ex-dividend may give a nice gap down day for the trader with a short position, they must pay that amount thus nullifying the benefit. However there might be on ongoing downtrend for the next week or two.
An example of a downtrend with a stock paying a 2% dividend is shown below in Chart 2.
Chart 2. Ex-Dividend Gap - Short position
While position traders can trade over Ex-dividend dates, they do need to be careful. As a general rule the Ex-dividend date is more important when the dividend yield is higher - especially above 2%. With low dividend payments below 1% the impact is not as great. With very low yields below 0.1% the effect is virtually insignificant.
News announcements pose some special considerations for position traders.
Position traders are often tempted to enter a position based a news event, especially when a chart pattern sets up in the direction that the news event supports. The problem here is that the news is almost always already factored into the stock's price. While insider trading is illegal, there always seems to be someone who knows. At the very least rumors surface and there are investors who capitalize on this.
This is a special problem for the position trader who is considering entering after a news release with a stock that has rallied prior to the news being released. The stock may well have setup a nice chart pattern and a breakout to the long side looks promising. The catch is that the stock has already rallied prior to the news being released and the upside breakout is probably going to be short lived as profit takers make their move. The end result is that the position trader gets stopped out, usually at a loss.
The exception to this scenario is if the news event is only the beginning and there is likely to be further good news to come. In this case speculation will likely continue to drive the rally higher.
A news event such as a company announcing that it has increased its dividend payout ratio is a once off event with no further expectations to come. Thus the news event is of no further interest to the market.
However an oil exploration company who announces it has discovered a significant new oil field, but does not provide any details of its future earnings expectations will leave the market speculating as to its future worth. Speculators will likely continue to drive the stock price higher on the anticipation that this oil field discovery will lead to higher earnings. If the company provided details in the news announcement of its impact on future earnings, then all the information is available and there is nothing left to speculate on.
Building a Position Trading List
How to find good position trading candidates for your portfolio
The purpose of building a trading list is so that the position trader has a short list of stocks which they can track daily for a trade entry. This short list includes stocks that are of particular interest to the position trader and have a good chance of signaling an entry. Tracking the entire market involves too much work and is also not necessary since the position trader is only looking for the better opportunities.
There are numerous approaches that can be used to create a trading list of stocks. The list needs to be manageable and if there are too many stocks on the list then the position trader is unlikely to perform an adequate analysis of each stock since they will be simply trying to get through this large list. A smaller list makes it easier to thoroughly analysis each stock on a regular bases.
Some position traders feel that they need a large list since they do not want to miss any opportunities. This is a misguided belief since the whole point of a short list is to reduce the number of candidates to a manageable level. Also if the position trader attempts to analyze too many stocks at once, their entry choices will in all likelihood be poor choices and they will probably just end up with losing trades. A few good trades that make a profit are better than a lot of trades that lose money.
The number of stocks on the list is a personal choice. As a guide, position traders generally have somewhere between 20 to 50 stocks in their trading list. The number of suitable trading candidates is dependant on market conditions and the short list may be considerably smaller.
There are numerous methods position traders can use to locate potential trading candidates. There is no right or wrong way and the method used is a personal choice of the position trader.
One of the simplest methods of reducing the number of stocks available on the stock market is to run a scan using a charting software package. Also some stock brokers have a scanning facility.
Generally position traders should only trade stocks that are traded each day. Some stocks do not trade every day and these stocks can make it difficult for the position trader to exit their position. A simple filter to use is to scan for stocks which have an average daily volume greater than a minimum limit. The average volume can be over the last 20 days or more. The minimum is a personal choice but as a guide stocks with an average daily volume of 200,000 shares is about the minimum position traders will consider trading.
Some position traders prefer to trade exclusively using chart indicators. These position traders run scans using their preferred indicators which provide them with a list of potential trades. They can configure their scans to only include stocks that have triggered an entry signal. Not all stocks on the scanned list are suitable candidates. The position trader will visually examine the stock chart of each candidate and make a short list of stocks that they think have the greatest potential.
Most position traders generally prefer trading stocks in the direction of the general. The simplest way to scan for up trending stocks is to use a technical indicator such as moving averages. Rather than use the indicator as an entry trigger, the position trader can use the indicator to scan for stocks that are in an uptrend for long side trades. If the position trader is looking for short side trades then they use the scan to locate down trending stocks.
The position trader can then visually examine the stock charts to locate stocks that are setting up a chart pattern and include these stocks in their short list. This short list is then monitored on a daily basis for a breakout.
It is good practice to visually examine the chart
for each potential trading candidate
Some position traders have a preference for a particular market capitalization. They may prefer large-caps or have a preference for small-caps. It is simple enough to filter the scan to only include market caps that are desirable.
The two main exchanges are the NYSE and NASDAQ. Some position traders have a preference for NYSE stocks while others have a preference for NASDAQ stocks. There are position traders that like to trade the micro-caps on the Bulletin Boards such as NASDAQ BB and the pink sheets. Whatever exchanges the position trader prefers, the scan can filter for these stocks.
A useful concept position traders often use is that of industry leaders and laggards. Stocks within an industry group have a tendency to move as a group. When the leader (which is a major dominate company in the group) makes its move, the minor smaller stocks tend to follow.
Using the industry Leaders and Laggards concept, the position trader looks for minor stocks that have setup a chart pattern and monitors these stocks for a breakout. Typically the leader in the industry group makes its move first and the smaller stocks will probably follow the leader in whichever direction the leader moves. This provides the position trader with an additional conformation if the breakout from the minor stock is in the same direction as what the leader is already moving in.
Using the Leaders and Laggards approach the position trader locates the industry groups that are performing strongly. The easiest way to do this is to check the industry based indices. Some scanning packages allow the position trader to scan through each industry group to short list stocks from each industry group. The alternative method is to visually check the chart of all the stocks in the chosen industry group and short list those that are of interest.
With this Leaders and Laggards approach, the position trader has a short list of potential candidates for each industry group which was determined to be performing strongly. These industry group short lists are monitored daily for a trade entry.
The short interest in a stock is another useful concept some position traders use to filter the stocks on their trading list. The idea behind this concept is that stocks with a high short interest have an additional source of buying pressure when the stock breaks out and rallies.
A stock that builds up a large number of short sellers and then rallies rather than selling-off, leaves these short sellers with a losing trade who will probably exit at their stop-loss levels. Since these short sellers must buy stock to exit their short position, this provides extra demand for the stock. Some position traders carefully monitor the short interest and base their trades on this information. Some scans can provide a list of stocks with a high short interest ratio. An alternative method is for the position trader to manually check the short interest of each stock in their trading list.
The number of potential candidates is largely dependant on market conditions. A bull market will provide more long side trading candidates than what a bear make will. Also as the bull market progresses the number of long side trading candidates increases.
While there are other considerations position traders can take into account when producing a trading list, the methods discussed include the common approaches used by position traders.