Apple Daily --- July 23, 2000

The most painful headache an investor has are usually two things: where to cut loss and where to take profit. Today we will discuss how to use Modal Points to devise profit-taking strategies.

Profit taking is not an easy task. It is fair to say that taking profit correctly is even more important than forecasting the market correctly. Even if one guesses the market right in the beginning, if he does not have a proper profit-taking strategy, sooner or later, the market will eventually turn against him and wipe out all his floating gains. On the other hand, if an investor can get out of the market on time, then even if he had guessed the market wrong in the first place, it is possible that he could still obtain a nice profit.

Unfortunately, most investors spend too much time on when to enter the market and do not put much thought on when to exit. Subsequently, even their forecast is correct, either they cannot win much because they take profits too early, or they lose back all they earn because they take profits too late. A proper profit taking strategy requires careful judgment and discipline. It also requires one to continuously monitor the market closely and react appropriately to the changing market conditions. One just cannot outperform the market if he simply adopts a buy and hold? strategy.

The Figure below shows the Prosticks chart of Wharf Holdings (0004). We will use this chart to illustrate how one can use Modal Points to devise a profit-taking strategy.

Suppose we are so smart to have bought the stock at A, and within a week, the stock rallies strongly from $13.5 to $17.8 (marked D in the figure), a nearly 30% gain in a single week. At this point, the trend is clearly on the upside and of course there is no reason we should be hasty to take profits and get out of the market. Usually after a strong rally, the market will enter a correction phase. As expected, for the few days after D, the market undergoes a correction and price falls from $17.8 at D to nearly $16.15 at E.

At E, we may then start to hesitate. Should we continue to hold or should we liquidate? If we liquidate now, we still have 20% gain which is not so bad. However, we believe that the medium term trend is up and we certainly would be very frustrated if after we liquidated, the market resumed its uptrend again. Therefore, what should we do?

As we all know, Modal Points are levels of support and resistance. Conventional technical analysis dictates that when a support (resistance) is broken, price will fall (rise) until the next support (resistance) is reached. Thus, when the market breaks below a major Modal Point, price should fall to the next major Modal Point.

Looking at the Prosticks chart, we will agree that the Modal Points of A, B, C, and D are major Modal Points. This is because all of those bars have very long ranges and are both rising and gapping, signifying that strong and persistent buying forces have occurred at those bars, particularly at the Modal Points which are most actively traded during those days.

As such, when price corrects from D and E, and we worry that the market may continue to erode our floating profits, we can define a critical price. We tell our broker that if price falls below this critical price, we will exit our position and take profits. This critical price has to be defined in a logical way, and cannot be generated using a random process.

Using the Prosticks chart, at E, we will set the critical price to be the Modal Point C (which is $16.05). As explained above, if the market really pierces below the strong Modal support of C, price would continue to fall until the next major Modal Point B is reached. Thus, setting the critical price at C offer us logical protection point.

As can be seen, the correction phase indeed ends at F which is exactly the same price as the Modal Point C. Our broker certainly raise his eyebrows, widen his eyes and praise our magic. What should we say to him then?