Comic Will Rogers famously observed in the 1920s: “The stock market is easy. Buy stocks that go up. If they don’t go up, don’t buy them.”
The old line of a character played by W. C. Fields, when he was asked if poker was a game of chance – “Not the way I play it,” Fields replied.
Here’s the key: I’m a very fickle guy. As long as a company keeps performing, I’m happy. When things start to look iffy, I cut and run. If you like home runs, here are my personal favourite criteria for picking stocks:
If you’re a day trader, an EPS – ‘earnings-per-share’ – ranking of over 90 is a must. You can check the Investor’s Business Daily newspaper, or online, for EPS coverage. It’s all laid out for you quite nicely, and is easy to read. The EPS rankings are well presented. Your target stocks should trade in excess of 100,000 shares a day to get the action you want. After all, you want volatility.
Keep in mind that the U. S. market is larger and more liquid, and has more shares available at more volatile prices than the Canadian markets.
If you’re a position trader, a stock should be in a clear uptrend above the 200-day moving average. Otherwise, say “No thanks!” If your stock falls below this moving average, it’s time to sell. This strategy is 90% to 95% accurate. It will never get you in at the bottom, or out at the top. But, at least it will get you in for at least 80% of the move, and keep you away from disasters.
In a survey of professional and semi-professional traders, 95% of them agreed that failing to cut losses resulted in the largest trading loss they ever had. This lack of self-discipline is the single most common thread to most traders’ losses. The most common reason cited for not cutting the loss early was that they thought the stock would ‘come back’ (think Nortel). Simply controlling your losses and setting stops (actual or mental) will dramatically improve your bottom line profits.
And did you know that a 20-year academic study PROVED that companies which have this number moving in the right direction return an average of 15% a year… compared to the measly seven per cent a year you’d get from companies with a bad number?
You might find it interesting to know that the number I’m referring to is ‘Number of Shares Outstanding.’ So what, you say? Who cares what how many shares of a company’s stock are outstanding? Tell me about cash flow, earnings, and revenue growth!
You SHOULD care, because companies where the number of shares is declining have an AWESOME probability of outperforming the market!
The reason is simple: when companies buy back their own stock, they are voting with their shareholders money to invest in something that they KNOW is dirt cheap – their own stock. These companies aren’t stupid – they only buy their own stock when it’s low, and sell it when it’s high.
Buying back shares makes the stock go up for good reason – other investors see the company’s confidence in itself. And, simple algebra tells us that current earnings divided by fewer shares means INSTANTLY higher earnings per share!
As companies reduce their shares outstanding, the earnings per share increase, making each share more valuable. This is ultimately reflected in share prices.
The stock of an average company announcing a repurchase plan will beat the market.
Makes sense, doesn’t it? After all, when a company buys back their own stock, it’s an enormous vote of confidence by those who know it best – senior executives.
But, those executives aren’t talking. They keep their plans, research, and tactics behind closed doors. The only indicator of their well-founded optimism is a stock buy-back. It’s a powerful indicator that no serious investor should ignore.
In the 10 years (up to 2001), if you had invested $10,000 in a typical S&P 500 portfolio, your investment would have grown to $67,917. But that same $10,000 invested exclusively in value buyback stocks would have grown to $130,254 – nearly $70,000 more in profits!
Buybacks are announced almost on a daily basis in the financial section of national newspapers. All you have to do is unearth them, and voila!
The Dow is the number that measures the market for Main Street on a daily basis. It is referred to as the benchmark for the U. S. market. It carries a lot of weight with traders, who consider its blue-chip stocks the ultimate bellwethers of the U. S. economy. There have only been a handful of changes to its composition over the years, and there were no changes at all between 1959 and 1976. Talk about stability.
According to ‘Mr. Dow’ – market strategist Charles ‘Chuck’ Kadlec – the Dow will advance at an 11.1% annual rate long-term, which means it would double three times in less than 20 years. Just by way of comparison, Warren Buffett – the Wizard of Omaha – believes returns during the next decade or two will average about seven per cent a year after inflation and frictional cost, such as trading fees.
The DJIA is an average of the prices of its major companies whose stocks are listed on the New York Stock Exchange. The Dow uses a weighted number that takes into account stock splits and dividends, when determining the index’s movement.
This is an investment strategy that historically has outperformed the Dow Jones Average, more often than not.
List all stocks included in the DJIA from highest to lowest in terms of dividend yield.
Select the 10 stocks with the highest dividend yield, and invest an equal amount on money in each. You’ve just bought some of the biggest and most well-established corporations in the world at a value price.
Repeat the process each year at a set time. Adjust the stocks in your portfolio as necessary, making sure that the stocks included in the portfolio have the highest dividend relative to their prices.
History has shown the 10 highest dividend-yielding stocks have typically provided investors with above-average total returns. In fact, this strategy has outperformed the DJIA 14 of the past 20 years.
This strategy is so successful, because the companies listed on the Dow are well-established and financially sound. This gives them stability and staying power even during economic downturns. The 10 highest-yielding stocks are typically companies that have been temporarily undervalued by the marketplace. Therefore, when these companies rebound, they are likely to provide you with an above-average total return. The strategy buys equity stocks that are out of favour. This ‘contrarian’ discipline has historically yielded above-average returns for equity investors.
It appears this strategy will work with other indices as well. If you’re considering investing in Canadian or other markets, this strategy provides a simple way to add global diversification to your portfolio.
Window dressing is a term used to describe the process whereby mutual fund portfolio managers sell the ‘bad’ or unpopular stocks in their portfolios at the end of their reporting quarters, in order to buy stocks that have performed well in that same period. They do so, because they must provide shareholders with reports of stocks they own on the last day of the quarter. By buying the best performers, they seduce shareholders into thinking that they have owned the best stocks all along. Boo hiss.
As you can appreciate, this trickery tends to create selling pressure in underperforming stocks and buying pressure in outperforming stocks going into the last week of every quarter. Knowing this, short-term traders who short the biggest losers and go long the biggest winners of the quarter make nice quick profits.
The January Effect is associated with a tendency for stocks, particularly those of small firms, to rally in the first two weeks of the year. This phenomenon is generally associated with December/January portfolio adjustments, or ‘window dressing,’ by fund managers.
If you’re a day trader, you are primarily interested in EPS, volatility, volume, and good trading technique.
After forming the head, which can be double by the way, price corrects back to initial support, rallies but then rolls over, forming the right shoulder of the pattern. When price falls through the neckline, that zone reverses roles from support to resistance as traders, fearful of giving back profits or wanting to cut losses, sell into strength.
The upside-down version of this pattern is an indication of a basing formation.
If volume surges as price drops, this is bearish. If volume drops as price surges, this is also bearish.
When you are reading this next piece, be sure to refer to the section below called ‘HORSEBACK RIDING.’ An upside breakout, not accompanied by increasing volume is suspect, because it does not have the buying power to support a sustainable trend. The actual level of volume does not have to be spectacular, but a definite change in the previous declining trend in volume should be readily apparent.
Downside breakouts are a different story. Here, prices can easily collapse with a lack of bids. Volume can be light or heavy. Light volume is okay, because volume is just following the trend, which is down. If prices are falling, it is reasonable to expect that volume will also be contracting. Falling prices accompanied by expanding volume signals urgent selling. This can also be a precursor to a downside breakout.
When a near-term top is done on relatively light volume, that usually means that any pullback will be limited.
If price consolidates as volume spikes, this confirms overhanging supply, as selling stops the advance. Volume is one thing, but On Balance Volume tells you the whole story – how much of the volume is going into buying versus selling. You can have lots of volume, but you must know what’s driving it. If more of the volume is made up of selling than buying, price doesn’t stand a chance. This is perhaps one of the most important indicators you should watch. It will give you ‘The Big Clue.’
A solid breakout is constituted by price closing for two consecutive sessions above or below the pattern. For day traders, this would translate into two five-minute or 30-minute bars, etc. By looking for two consecutive solid closings above or below the pattern, you are in essence validating the legitimacy of the breakout.
To protect yourself against whipsaw breakouts, you could place a stop below the previous minor low prior to the whipsaw rally. If that poses too much risk, then use ‘the 50% rule.’ This entails placing your stop just above or just below the halfway mark of the pattern, depending upon which way you are playing the pattern – i.e., going long or short.
I personally like to buy on an upside breakout, wherein I am expecting my price objective to be met quickly. Oftentimes, however, the price will experience a retracement move, offering a second chance to buy under quieter, more controlled conditions than those associated with the breakout. You can construct a downtrend line by joining the minor retracement peaks. When this line is violated, this denotes a buy signal.
A double bottom is the exact opposite. It is pretty much the same thing happening, but here you have two reactions developing at around the same level and a rally on strong volume (indicating aggressive buyers) that takes the price above the previous peak – in between the two bottoms. The first leg of the double-bottom formation usually occurs on heavy volume. The second leg down is typically characterized by lighter volume. An air of bearishness sets in, as traders get disappointed in seeing the initial rally off the first low all but retraced in the second swing down to the second bottom of the formation. For a valid breakout to occur, volume has to expand, as complacency at the second bottom is replaced by enthusiastic buying, and the price breaks out beyond the high point between the two bottoms.
When the other line of a right-angled triangle is declining, the triangle is known as a ‘descending right-angled triangle,’ and it signals bearishness. When the other line is inclining, you have an ‘ascending right-angled triangle.’ In the case of an upside breakout, the horizontal line acts as resistance before the breakout and support afterwards. In the event of a downside breakout, the horizontal line acts as support, until the breakout occurs and then becomes resistance.
A breakout from a right-angled triangle is usually more powerful than one from a symmetrical one. A breakout can be a continuation of the previous trend prior to the formation of the triangle, or it can be a reversal. What happens in some cases is a breakout may in fact be invalidated, if it fails and simply converts the triangle into a rectangle. This, in and of itself, is not a big deal, as the breakout may then occur as a breakout from the newly formed rectangle.
Sometimes you get a surprise directional move when a breakout from a right-angled triangle goes in the opposite direction to what you expected. However, equally noteworthy is the nasty reversal of fortunes when the unexpected breakout fails. For example, this can occur when the failure to rally above the horizontal level of resistance leads to exhaustion.
A good way to determine how far price will go after the breakout is to measure the deepest part of the triangle, and use that distance to gauge how far price will go away from the point of departure.
On the ‘Sell Day,’ the long positions acquired on the ‘Buy Day’ are sold at or near the previous day’s high. What is happening here is nothing more than smart money taking profits, where resistance exists. One would think that the market would now decline – but first, it is ‘engineered’ higher. On the ‘Short Sale Day,’ the market opens higher and rallies. But, the rally is short-lived, and soon after the market declines, closing near its lows. The appearance of strength has fooled the buyers. After the three-day cycle, the buying strength has dissipated, and lower prices become the path of least resistance. Once again, the smart money is on the right side, selling near the highs.
This pattern appears again and again – only to disappear, and then reappear once again. It may be consistent for four or five weeks, and then disappear. It is most consistent in markets that are not trending.
Late-day momentum in a particular commodity, currency, stock, or the overall market typically carries over into the first part of the next day. Watch the close for a good idea of the next day’s open.
2. The trading range of the first bar should be wide by previous standards. This confirms the strong underlying momentum of the prevailing trend.
3. The trading range of the second bar should be much smaller than the first, which tells us the balance between buyers and sellers is much more evenly matched and the balance is tipping. The sharper the contrast between the two bars, the greater the potential for a reversal.
2. The price opens strongly in the direction of the prevailing trend – above the previous close.
3. The trading range is very wide.
4. The price closes near or below the previous close. A classic reversal finishes below the previous bar’s low.
5. Volume should be climactic on the key reversal bar.
6. The upper end of the bar sticks out like a sore thumb above the previous two sessions. The price breaks out strongly to the upside, but is unable to hold its gains and, by the close, it gives up ground over the previous period.
7. Alternatively, the price opens close to its low, and closes higher in the opposite direction of the prevailing trend.
8. The extremely high volume is the tip-off that either buyers or sellers are exhausted, and the next trend is likely to be down or up.
2. The opening price is at a higher level than the previous bar’s close, but the closing price of the outside bar is not only down on the period – it also closes below the lowest point of the previous bar. If the price closes down a little, it is not as strong a signal as if it closed down sharply.
3. Alternatively, price opens lower, and then goes lower still, before finally closing up on the bar.
4. If the outside bar encompasses the trading range of three or four bars, it is likely to be more significant than if it barely encompasses one.
2. Then, for the rest of the period, price declines, and the close develops at the bottom of the bar.
3. This is definitely an outside bar, but the fact that it closes so weakly indicates it is not an exhaustion move in the classic sense.
2. The first bar of the formation develops strongly in the direction of the prevailing trend. In an uptrend, we need to see the close of the bar at, or very close to, its high.
3. At the opening of the second bar, the price should open very close to the high of the previous bar.
4. A change in psychology takes place, as the second bar closes slightly above or slightly below the low of the first bar, indicating a change in trend.
5. To be truly effective, this must be a climactic experience. The two-bar pattern really needs to be preceded by a persistent trend, and the two bars in question should stand out as having exceptionally wide trading ranges.
Tom DeMark goes one step further, and takes into account two consecutive bars in the definition of his TD DIFF indicator.
If the closing prices of these two bars are both lower than their respective previous bar’s close, he compares the difference between each bar’s low and close. If the difference is greater for the current bar, he suggests that price will probably rally.
Conversely, if the closing prices of the last two bars are both higher than their respective previous bar’s closes, he then compares the difference between each bar’s close and high. If the difference is greater for the most recent bar, he concludes that price will have a tendency to decline.
The market may take off on you in the form of a ‘V’ bottom. Or, it could sag sideways – and this is not desirable. Alternatively, prices could form a ‘W’ or ‘1-2-3’ bottom. Let me explain. Prices reach a low point (the number one point), and then rally. A short rally to a high point (the number two point) is followed by another decline to the number three point, which is not quite as low as the number one point. It’s as if the market is checking if this is indeed a low, or bottom.
The rally that follows is a little more solid. Prices traverse the high of the formation – the number two point. This constitutes the breakout that you should be looking for. In anticipation, you should always place a ‘buy stop’ just above the number two point. After the breakout, the market once again tests itself, and checks the move to see if it is legitimate – but does not violate the breakout point just above the number two point.
Every astute trader manages his money wisely. Accordingly, it is appropriate to place a sell stop just underneath the number three point of the above formation, just in case the trade breaks down. I personally favour a two percent stop – two percent below your entry point, just because that’s my own rule.
One further thing, if the distance between the number two point and the number three point is extreme, this denotes more risk. The less distance, the less risk.
Let me elaborate… The 200-day (40-week) moving average facilitates a simple strategy that is 90% to 95% right: Sell a stock, when it falls below its 200-day moving average. If a stock is clearly in an uptrend above the 200-day moving average, stick with it. Otherwise, kiss it good-bye.
As previously stated, this strategy will never get you in at the bottom or out at the top. But, it will get you in for at least 80% of the move and get you out of a disaster.
I personally favour using the 200 EMA, as well as the 50 EMA, both of which focus the MAs on more recent price action. EMA stands for Exponential Moving Average.
However, most of the time, when a stock is going up, the money flow is going up. And, most of the time when the stock is going down, the money flow is going down.
What money flow analysis is is just the modern day version of tickertape reading. Several decades ago, before the advent of computers or data retrieval systems, traders would watch ‘the tape.’ They would be watching for any unusual activity as they studied this trade-by-trade record of transactions of the New York Stock Exchange.
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