Here's Why I Will Never Buy Another Stock

Placing a market buy order for a stock is the most audacious statement I can make. I am saying that the world is wrong and I am right. The stock has been going down-down-down and looks absurdly cheap.

So I jump in and buy it, thereby going against the cumulative opinions of the entire world. I am saying I am so smart I can tell you when it is going to stop going down. That is not very bright. Success in accumulating stocks, especially from an aggressive trading standpoint, is recognizing the price direction early in the move, and participating in that move. That means going with the flow, not against it. Picking bottoms is not the way to do that, since I would be going against the flow not with it. Even a limit order to buy is a way of declaring that I have the uncanny ability to pick the exact bottom.

In my new book, entitled "Stop and Make Money", I suggest a way around this dilemma; the stop order to enter positions, whether long or short. By placing a stop to buy, for example, I am saying that I am willing to pay a little bit more for the stock, if I know it is going in my direction. Similarly, a stop order to sell, below current prices, says I only want to be short the stock if it falling. In this manner I am always going with the flow, not against it, and that leads to profits. I may not be buying at the bottom, nor am I selling at the top, but I am taking a nice chunk out of the middle.

The key of course, is knowing when a true turn has occurred and placing the stop order at a level wherein it does not get activated by a false move, nor does it leave too much money on the table. Hence the new book. It incorporates the methodology of my four previous books on technical analysis, and applies the stop order psychology.

Equivolume Charts

That methodology centers on Equivolume Charting. I first revealed this technique of depicting price and volume action many years ago, and it is now available in popular charting and analysis programs with Metastock being the best, I believe.

Shown below is a typical Equivolume chart, Mentor Graphics (MENT | Quote | Chart | News | PowerRating), posted on daily basis. You will note that each entry is a box, rather than a line, as is the usual bar chart method of depicting stock action. Each box represents one day of trading, with its width being the volume on that day.

• Wide box = heavy trading
• Narrow box = light trading

The vertical dimension is the trading range. So it is a typical bar chart, stretched sideways to account for trading volume. Each entry is distinctive box, with a shape that tells us how easy or hard it is for the price to change. Thus an entry that is short and wide indicates heavy trading in a narrow trading range, and is often seen at tops and bottoms as volume expands but movement becomes difficult. Conversely, tall and narrow boxes imply easy movement of the price. It is not taking very much power to move prices.

Example of Entering a Stock Using a Stop to Buy

On this chart I have shown the stop methodology in practice. After a long decline there is a burst of strength but off such a narrow turning point that it looks unsustainable.

Mentor Graphics (MENT) 2007 - Chart by Metastock

A pullback is to be anticipated at that time. We do have the pullback, and it is on lighter volume, which is what we want. It takes the form of a very typical flag. At that point the stock looks as though it should be bought if it resumes its advance. Therefore, a stop to buy order can be placed just above the upper limits of the flag. When the advance resumes the stock is immediately bought. The beauty of the strategy is that if the stock falls too far, making the validity of the original strength suspect, the stock never gets bought. If it is not acting right we merely cancel the stop buy order.

Here are the rules to identify opportunities to place a stop to buy order:

1. A reversal from a downtrend is accompanied by short and wide Equivolume boxes.
2. The market turns up.
3. Place a stop to buy order above a short-term resistance level as a new uptrend is established.

Example of Entering a Stock Using a Stop to Sell Short

Some consolidations are wider lateral moves, as in the chart of Huntington Bancshares (HBAN | Quote | Chart | News | PowerRating), shown below. In this case a stop order to sell short just below the support level would have initiated a very profitable position. Notice how volume expanded (wider box) and the trading range also became larger (taller box) as it dropped through the old support level. That was an unequivocal signal of weakness.

Huntington Bancshares (HBAN) 2007 - Chart by Metastock

Here are the rules to identify opportunities to place a stop to sell short order:

1. A reversal from an uptrend is accompanied by short and wide Equivolume boxes.
2. The market turns down.
3. Place a stop to short-sell order below a short-term support level as a new downtrend is established.

These are just two brief examples of how the Equivolume technique can be merged with stop orders to produce profits. It is a way of never fighting the market, but always going with it. It means never telling the market what you think it is going to do, but rather, observing what it is doing, and capitalizing on that observation. Try this and you too may never place another buy or sell order, but only stop orders.

Richard W. Arms, Jr., is one of the world’s most respected Stock Market personalities. His technical work is used worldwide and he has been a guest speaker on four continents. He is the inventor of the ARMS INDEX, also known as TRIN or the Short Term Trading Index. He originated and popularized Equivolume Charting. In addition he is the developer of Ease of Movement studies and of Volume Adjusted Moving Averages.

Richard's five books have been translated into a number of other languages, and his methodology is familiar to most stock market traders and professionals in every financial center. He makes frequent appearances on financial television, nationally and internationally. He was the 1995 recipient of the Market Technicians Award for his lifetime contribution to Technical Analysis.

http://www.equis.com/arms