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Thread: A complete example: Long POT

  1. #1

    A complete example: Long POT

    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.)

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    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.

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    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!!

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    But let's come back to the Breakout Calculator (BC.) (see the icon description below.)

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    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.

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    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.

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    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.

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    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.

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    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.

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    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.

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    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!

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    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.

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    A sensitivity analysis shows that we indeed should wait for pullbacks that are at least -0.5% below the 5MA.

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    We could also test a breakout such as the one that occurred in November.

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    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.

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    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.

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    Hence, let's change the stop to just below the 5MA.

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    Results look better, but still not very impressive

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    Let's now try a Breakout on Volume (BOV type of trade), using $36 as stop level.

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    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.

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    We can see below that even stronger breakouts do not offer good opportunities.

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    We can also see below that keeping breakout trades for more days does not improve the general picture of the trade.

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    Conclusions:

    The best is to buy POT on pullbacks below the 5MA and keep the trade for 15 days.
    Last edited by Pascal; 02-02-2015 at 06:58 AM. Reason: Envelope size: 2.4% instead of 2.6%

  2. #2
    The POT long trade still looks interesting as of the close of Feb 10


    Pascal

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  3. #3
    Join Date
    Dec 1969
    Location
    New Jersey
    Posts
    189

    Envelope?

    Hello Pascal,

    I am trying to better understand the envelope calculated by the breakout calculator. You state "We can see below that the 2.4% envelope captures 90% of all the price bars for the analysis period." This essentially means only 1 of every 10 bars (on average) should break the envelope. From the naked eye, it certainly looks like more than 1/10 bars break the envelope if you count the # of break vs. # bars. I annotated visible breaks below.

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    Is this simply due to the envelope was created using a longer data set than the figure shows? From the naked eye, the envelope looks too tight to capture 90% of the moves. Maybe the envelope is calculated using closes vs. high/low? Any insight is greatly appreciated.

    Harry

  4. #4
    Good question indeed Harry.

    It is not the number of time that the price pokes outside of the envelope that we count to set the envelope size, but it is the total length of the bars that is outside of the envelope compared to the total length of each bar. We want that less than 10% of the length of all bars fall outside the envelope.


    Pascal

    Quote Originally Posted by Harry View Post
    Hello Pascal,

    I am trying to better understand the envelope calculated by the breakout calculator. You state "We can see below that the 2.4% envelope captures 90% of all the price bars for the analysis period." This essentially means only 1 of every 10 bars (on average) should break the envelope. From the naked eye, it certainly looks like more than 1/10 bars break the envelope if you count the # of break vs. # bars. I annotated visible breaks below.

    Attachment 28400

    Is this simply due to the envelope was created using a longer data set than the figure shows? From the naked eye, the envelope looks too tight to capture 90% of the moves. Maybe the envelope is calculated using closes vs. high/low? Any insight is greatly appreciated.

    Harry

  5. #5
    Join Date
    Dec 1969
    Location
    New Jersey
    Posts
    189
    Thank you - makes sense to me now.

  6. #6
    POT has been weak in the past days. I believe that it will pull below the 5MA.
    I sold and will reenter later. Around $36.3 cold be a good entry point.


    Pascal

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