How to Avoid Analysis Paralysis on Your Next Trade
We’ve all been there: You’re watching a stock, it keeps moving higher and as you keep waiting for an opportunity to buy, the thing keeps climbing. I’m talking about analysis paralysis — and it’s a trader’s worst enemy.
Last week, I got an email from a Trend Playbook reader asking about this exact scenario:
“I have been reading your Trend Playbooknow for several weeks; very good instruction, thank you. Here is one stock, TTC, I have been watching. Haven’t jumped in, but wish I would have a couple months ago…“By application of the trend analysis that you have been promoting, it looks like it should be a great buy on a pullback toward the support line. However, each time it pulls back, the question surfaces: What if this is the point at which it has hit overhead resistance and is going to start falling? Then the low is missed and story goes on.
“Any advice on how to make the decision when to buy in on this stock (or not)?
“Thanks,
“RSH”
Trading is tough precisely because of situations like these. Buying a rising stock goes against human nature — after all, we’ve all been told to “buy low and sell high,” right? But I’m getting ahead of myself. We should probably start off by taking a look at the stock our friend was asking about: The Toro Co. (NYSE:TTC).
Toro makes lawn care equipment like mowers and sprinklers. Apparently, that’s been a booming business — take a look at Toro’s chart:
Clearly, TTC has been in a solid uptrend for the last year. And our friend is right — buying a pullback to support has been a good move each of the last six times Toro did it. Support levels like this work because buyers are continually upping their expectations. As Toro made new 52-week highs at the start of the year, everyone who had bought shares recently was sitting on gains. That’s helped to reduce selling pressure psychologically, since there weren’t any shareholders who could say, “As soon as shares get back to even, I’m selling.”
Sellers are a whole lot less forceful when everyone’s sitting on gains…
So how would I trade this stock? I’d wait for a pullback to support, but I wouldn’t buy as soon as TTC got close to that support line. Instead, I’d wait for a bounce higher off of support before I jumped in. There’s a good reason for that: Trend lines all eventually fail — even this one. By waiting for a bounce, we know that there are still buyers sitting right under support who will help to keep a floor in the stock before we buy. Yes, you’ll sacrifice a few points on your entry, but you’ll also greatly reduce your risk of a losing trade.
Then, I’d put a stop loss at the 200-day moving average (the red line on the chart). After all, if shares broke below support, I’d know that the trend was now broken in TTC and I wouldn’t want to own it anyway. Keeping a stop just below support helps reduce your risk even further without throwing away possible gains.
A Trend-Following Approach to This Stock
As faithful readers know, I’ve been writing about trend-following strategies here in Trend Playbook for the last couple of months (click here to catch up). Our friend even asks how TTC would work with that strategy. That’s a really good question.
You see, the trading approach I just described isn’t a trend-following system.
Yes, I’m trying to catch the uptrend in TTC by buying at support, but also I’m making discretionary decisions about the trade. That may work fine for an experienced trader, but it’s a whole lot harder for other folks who don’t have as much experience trading this market.
That’s the beauty of trend following: It’s completely nondiscretionary. In other words, I do what my system tells me to do, regardless of my emotions or my biases.
Experience is needed to make up the system’s rules, but it’s not needed for use the system. That’s really important!
As an example, let’s see what happens if we apply the super-simple moving average rules I showed you back in September to TTC: We would have bought TTC when it moved above the red moving average back in mid-December, and we’d still be holding it for 41% gains today (since it didn’t close back below the 200-day moving average over the period, it hasn’t triggered a sell yet).
Notice that by following that approach, we didn’t buy at support (any of the blue arrows on the chart). As a trend follower, you’re not trying to pick tops and bottoms. You’re just trying to grab the majority of the trend. More importantly, you didn’t need to be able to spot support levels or figure out what constituted a bounce off of support to know when to buy. You just would have bought when TTC closed over the 200-day moving average.
Following simple hard rules is the best way to avoid analysis paralysis on any trade.
As I mentioned last week, trend following isn’t foolproof — you’re not going to win 100% of the time. In fact, you’ll probably win less than 50% of the time. But that’s by design! In the end, trend following produces much bigger gains than buy and hold with much less risk. And I’ve got the charts to prove it.
Next Friday, I’ll show you another step toward putting a trend system to work for your money. Stay tuned…
Until then, continue to send any questions to trendplaybook@agorafinancial.com.
Enjoy your weekend,
Jonas Elmerraji, CMT
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Jonas Elmerraji
Jonas Elmerraji, CMT, is the co-editor of STORM Signals and Penny Stock Fortunes, and a contributor to Agora Financial’s Trend Playbook. Jonas got his start on the fundamental side of the market, poring over financial statements and valuations to find sound investments – today, he specializes in blending fundamental and technical analysis. Jonas is a senior contributor to TheStreet.com, and has been featured as an investment expert in Forbes, Investors Business Daily, and CNBC.com among others.
Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.
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