Knowing how to enter into a position is just as important as knowing how not to enter into one. The two most common ways of botching an entry are chasing a stock past your ideal entry point and anticipating a move to an entry point too early.
When you decide to enter into a position, refrain from chasing a stock too far past your ideal entry target range. This does not mean that you cannot get into the stock; it simply means that instead of paying an immediate premium for it, you are waiting for it to pull back before getting in. You can get in on a pullback as long as the stock does not move excessively past your entry point. If it does move too far past your entry point and then falls back (a fallen star), it should be avoided. The chart in Table 11-1 can be used as a general guideline of the buffer zone ranges for entry, given the price of the stock. These ranges are meant to give you general criteria to prevent excessive chasing. They are not set in stone and should be used with a flexible approach, given the stock that you are trading or the circumstances you are trading under.
Table 11-1 Buffer Ranges for Stock Entry
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Most market makers are unwilling to chase a stock too far past an entry range in order to execute a customer's retail order. They prefer to short a stock to a retail buyer if the stock moves up excessively, rather than pay up for it. This is because stocks tend to pull back in a steplike fashion after moving higher.
For example, if a stock is quoted 3915/i6—40 and it begins to move, you should resist paying more than 403/s to get in. If you miss the move, wait for it to pull back into your entry range before getting in. If the $40 stock moves more than \x/i percent above 403/s, or in this case above 41, and then falls back into your initial entry zone, stay away from it. Market conditions could have changed. Your objective should be to buy stocks that are moving in your direction, not against you. The law of diminishing returns states that the higher the cost of entry, the lower the profit. When you understand this rule and abide by it, your profits will increase steadily.
Stocks that move more than 2l/i percent past your entry point without pulling back and consolidating before lifting off again are more the exception than the rule. If you have acquired the habit of chasing prices too far past the price where the motion began, then you are consistently paying a premium for entry. The disadvantage of paying a higher entry cost is evident across all businesses, not just trading. Any entity that regularly pays above the average price for its goods will have smaller margins and a tougher time earning profits.
Many traders tend to disregard entry cost. A 1/2 point move in a $20 stock is 2l/i percent; that is a stronger move in percentage terms than a 1/2 point move in a $100 stock, which is only 1/2 percent. Trading is a game of probabilities. Your chances for success in trading increase when the odds for continued motion are in your favor, not against you. Paying a premium for entry on a consistent basis after the motion has begun decreases your odds for successful continued motion under most circumstances.
The higher the price of the stock, the larger an entry buffer you should provide yourself with. For stocks that are priced at over $100, widen your entry buffer zone to roughly 3/4 of a point after the motion has begun. If your entry point is missed, you can always get back into the stock, but you should regard it as a new trade and a new short-term trend that you are attempting to catch.
Internet IPOs, for example, are not normal trading circumstances and should be considered a completely different trading ballgame. Day traders who try their hands at Internet IPOs use a different strategy than they use for most of the other stocks they trade. Because of the wild price swings with Internet IPOs, chasing the stock is often the only way to get in or out. Entry zones have to be huge, as do slippage adjustments. It is not uncommon for day traders to chase entry by 5 percent to 10 percent of the stock's price. The two most important things to watch when trading Internet IPOs are the AX, or the leading underwriter, and the spot where the motion began. These two items often go hand in hand, because the AX has the power to move the market due to a large natural customer order flow. If you trade Internet IPOs, use a predetermined limit for chasing entry and stick to it. Emotions of greed and fear run the highest with new issues. Resist the urge to hit the ball out of the park, and stay disciplined.
Traders usually chase stocks because they get emotional about having missed a move, and they want in at all costs. Buying a stock with upward momentum is a plus, but if the initial move is missed, you are better off letting it go. The chances are that another opportunity will materialize. Remember, missed money is better than lost money. Chasing stocks is the most common way to lose money when entering into positions.
Another common mistake made by professionals and novice traders alike is to anticipate a move into your entry zone before it gets there, with the motive of getting a cheaper price. When prices do not move to your level, there is usually a good reason. By anticipating the move, you are nullifying the reason for getting in.
Always wait for the price to enter into your sweet spot before acting. Use caution and refrain from anticipation. Anticipation is a dangerous quality to possess as a trader. Regardless of how tempting it may be to get onto the wave early, when you anticipate you are projecting your will onto the market. Allow the market to open the door for you before you act. Read the market's will, and refrain from imposing your own.
The problem with anticipating a move through support or resistance is that these levels are called so for a reason. The buyers or sellers of yesterday usually fortify those levels with increased resolve. The bulls or bears may be waiting in the wings to protect their territory. The very reason you are entering into the position in the first place is because of the evidence that the selling resistance or buying support has been nullified by today's stronger action. Anticipating a move to these levels is wishful thinking and has no basis in reality.
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