John Deere (DE)

DE has been one of my favorite stocks to trade over the past two years. It is such a fantastic company, and I admire their commitment to farmers and the environment. The current credit crisis has pummeled the stock, however, and in this trader's market, unfortunately one cannot hold the stock for long. But one can trade it!

Today, February 24, 2009, was a counter trend play based on three factors: after 10 days of downward movement, DE seemed due a bounce. However, one cannot assume in this market environment that something has to bounce. How many times have I said, "It just HAS to bounce!" and then said stock does not!

The other two factors in favor of the trade were bullish internals in the broad market for the day, and a clear monthly trendline which established a reasonable stop loss.

The disciplined trade requires setting a stop when you enter the trade. This guards against making emotionally charged decisions to stay in bad trades, and it requires proper planning ahead of the trade. Setting stops helps to think through the risk and decide if you are willing to accept it, while protecting yourself from a potentially greater loss. I have found that when you set a stop, you are confronted with the reality of what you could lose, and you may realize this is not a trade you are willing to enter. This can be a protection against entering into a trade that is too risky.

In order to trade using proper risk management, one must calculate the maximum acceptable loss in proportion to account size. Protecting capital is the first priority in trading. According to Investools, a fabulous investor education company, acceptable loss is 2 percent of your total account value. So if total account value is $10,000, acceptable loss is $200. In this case, one must set a stop that controls risk at a maximum loss of $200 for the trade.

In the case of John Deere today, I looked to long-term support to find the proper stop, since DE had fallen below levels of recent support (the October, November and December lows in the 28 area). The 10-year monthly chart showed potential support at 26:
So the stop for the day was 26. For a tighter stop, one also could use 26.50, based on a double bottom set on the 5-minute chart. This double bottom in the 26.60 area corresponded to the monthly trend line.

For a disciplined trade, the proper entry also has to be found. A safer entry could be executed using the 5-minute chart, entering as close to the 30 moving average as possible, after the 5 moving average crossed above the 30. This can show that the move has a bit of strength, and this entry proved to be wiser than chasing it on the open, which is often a big temptation. So in DE today, a good entry proved to be in the 27.20 area after this moving average crossover.

Of course, when using the 5-minute chart for entry points, the longer-term time frames must be kept in mind as well.

In this market environment, I have observed that taking quick profits is one way to ensure that good trades do not turn into bad ones! Large gaps down can wipe out nice gains, and they have become a regular event. Bad news in the stock overnight can lead to disastrous gaps down which can stop you out way below your original stop loss price. Even great companies like FedEx (FDX) have suffered recent, huge gaps down of more than $8 which can devastate a small account.

The last thing which one must plan in a disciplined trade is the proper exit! This is one of the most difficult decisions to make in trading. The euphoria of a trade going in your direction can cloud your judgment in when to take profits.

In the case of the Deere trade today, it seemed to me that exiting at 'Resistance 1' was a reasonable exit. That was 28.67, and I exited a bit below this at 28.60. One of my mantras has been, "You can always get back in," but it is imperative to not allow good trades to turn into bad ones!