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What's Your 'Worst Case' Scenario?

01/03/02 10:26:57 AM
by Don A. Singletary

Here is a strategy to make money from a 'blue chip' stock while the Dow is in a trading range.

Security:   AFL
Position:   N/A

To illustrate this strategy I chose AFLAC (AFL), but any good solid stock you follow and have long term faith in will suffice. I have traded AFL for years and am familiar with its behavior in all kinds of markets. In order for this 'buy and sell' strategy to work, you must consider the 'worst case' scenario -- you buy it, it doesn't go up, and you get stuck holding it perhaps for a long time.

The strategy is to buy AFL at $25.00 and sell it at $27.50 for a 10% profit. Remember to factor commissions into your profit. Since I use a discount broker I only pay $8.00 each way in commissions.

Once you determine the high and low of the trading range you can anticipate your entry and exit points.
Graphic provided by: MetaStock.
Graphic provided by: ESignal.
 
The attached chart illustrates the behavior of AFL and the S&P 500 since September 11, 2001. As you can see, AFL roughly moves in tandem with the S&P 500. The 'low' for AFL has been around 23.50 since September 11th, so I consider that area to be the likely, although not certain, downside risk for the trade. In my opinion AFL is a great long term buy at $25 or I wouldn't even think of buying the stock. Buying the stock at $25/share and then immediately placing an order to sell it at $27.50, when executed, will yield a 10% profit. I expect the S&P to be volatile over the next six months. If I am right and the stock makes the 'trip' between $25 and $27.50 even three times in the next few months, I will make about 30% in six months. If I am wrong, I will be holding a great stock, which I bought for an excellent price, for a long term investment. Either way is fine with me.

When you use this strategy you should consider purchasing a stock you have had experience with. Since September 11th I have made two 'trips' for 10% each and as of this writing I have a buy order in at $25 to purchase it again (I am using a buy-stop order which trades me the next tic after the stock trades for $25). If you have limited experience, stay with a market order to avoid confusion and to get the cheapest commission from your discounter.

If you do the math, you will see that I made a total of 20% on equity in the two trades since September 11th. That's 20% in two months. I will be happy if this produces similar results two more times in the next six months, which would give me a 40% return -- a return that I don't consider to be shabby.

This strategy should be done with a safe and solid stock so you don't have to worry too much about it or constantly watch the ticker tape. Most brokers will send you a notification when your order is executed. When you compare a strategy like this to the normal 'day trading' or 'short term' methods of picking a volatile stock and trying to anticipate what is going to happen, there is no comparison.

Good, sound investing involves a little creativity and common sense. Usually the simpler an idea is, the better it is. Though this strategy won't put you in any 'fast lane/high profit' trading, it does offer a relatively safe way of getting a great return. At 40% annual yield, your money doubles every 1.8 years.



Don A. Singletary


Company: Sing Systems Trading Information
Website: www.writethisdown.com
E-mail address: don@writethisdown.com

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