There are an increasing number of individuals who, frustrated by lackluster performance and high fees in their portfolios, are taking a more active role in their own investments. These people are beginning to look for opportunities themselves and allocate a portion of their money to individual stocks that they believe will outperform the market as a whole.
This is an admirable trend in many ways as there is nothing like taking responsibility for one’s own affairs, but, if you are one of those people, your chances of success are much better if you understand certain things about the approach of traders. For years, individuals have been told that trading within your portfolio is too risky -- that risk is something to be avoided and that you should essentially hold each position forever. A more active investing style, however, means that the opportunities you are looking at will often be short term in nature. In that situation, it is important that you understand and limit risk.
Nearly twenty years of working in dealing rooms around the world left me with a different perception of risk to that of most individual investors. In that environment, it is a way of life. You cannot avoid it, as there is no reward without it, but controlling risk is essential if you want to survive. To this end there are some fundamental chart patterns that present opportunities for trades where the potential losses can be known and established up front, an essential element to risk control, and an established range is one of those.
Of course, a stock stuck in a range has limited potential for profit, but if you believe that a break out to the up side is a possibility, then the bottom of the range provides a level below which you can accept that the idea hasn’t worked, and where you can take a small loss before moving on to the next idea. The four big US banks, Bank of America (BAC), JP Morgan (JPM), Goldman Sachs (GS) and Citigroup (C) all fit that description of a range bound stock with potential.
The potential comes from a belief that, despite several false starts in the last five years, the banking industry is poised to fulfill the promise that many feel is there. The key is that interest rates are beginning to rise, and in a rising rate environment the banks’ core business of lending and investing becomes more profitable. If you accept that premise, then investing in big banks makes sense. The risk comes from the fact that the sector has some unique dangers, such as increasing regulation that could prove more powerful in the short term.
Each of the four big banks have been essentially trading in a range since the middle of this year, so in each case, that short term risk can be guarded against by establishing stop losses at reasonable levels.
BAC, JPM, GS and C could all be bought at current levels with limited loss potential by setting stop losses just below 13.50, 50.00, 150.00 and 45.00 respectively.
Of course, for this to make sense, you have to buy into the basic idea that the big banks are about to finally start fulfilling their oft quoted potential, but in the current environment, that isn’t hard to do. Each one, however, could fall foul of regulators or face other problems at any time, so spreading your investment and limiting potential losses makes sense.
When you are interested in a stock and the charts show that it has been range bound for a while, that doesn’t have to be a negative. Sometimes, as here, the existence of an established range provides an opportunity to invest in an expected long term trend with a limit to the potential for short term losses. If you are starting to manage your own portfolio more actively then just looking at potential profit isn’t enough. Considering, and guarding against, the downside to a position is what traders do every day and you should start to do the same.