The Formula
Stockscores.com Perspectives for the week ending August 28, 2005
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In this week's issue:
One of the most frustrating things about the stock market is that on one has been able to make a science out of investing. No one has been able to find the magical formula that predicts future stock prices with 100% certainty. The market has escaped the bounds of scientific deduction.
We know that if you cool water to 0 degrees Celsius it turns to ice. Always. If you jump off of a balcony you will fall to the ground. Gravity always works. However, there is no formula for buying a stock that always leads to a profit. Until now.
Here is my formula for trading the stock market. While this has never been done, I offer it to you for free:
FSP = CSP + FD - FS
where,
FD = WPM
FS = WAL
FSP = Future Stock Price
CSP = Current Stock Price
FD = Future Demand
FS = Future Supply
WPM = Willingness to Pay More
WAL = Willingness to Accept Less
Simply put, stock prices will go higher when the willingness to pay more is stronger than the willingness to accept less.
Essentially, this formula describes what is central to economics. Prices go up when demand exceeds supply. Prices go down when supply is stronger than demand.
When I was in business school, I distinctly remember my Finance professor telling us that supply and demand had no influence on future stock prices. By definition, stock prices were based on the present value of future earnings expectations. The ability of the company to make money in the future determined stock price. Strong demand would not cause a stock to exceed this value because the efficiency of the market would ensure that supply would rise and drive stock prices down to their fundamental value.
Having traded the stock market for some time now, I can tell you that trusting the theoretical definition of stock price will not consistently make you money. It is not a scientific definition. The reason is that it is not fundamentals alone that affect our willingness to pay more or accept less for a stock.
Human beings are emotional creatures. Beyond fundamentals, it is our psychological state that affects how we judge information. People will assign a different value to fundamental change in a rising market than they will if the market is falling.
Therefore, it is the perception of fundamentals that determines future stock price. If we can predict how humans will behave when fundamentals change, we are halfway to predicting future stock prices.
We also need to predict fundamental change. This requires in depth study of the company with the hope of uncovering clues about where the fundamentals are going in the future. To be honest, this is a difficult task for one person to do on one stock, and virtually impossible to do on all stocks.
However, there are people who know more about an individual stock. Every stock has a group of people that can predict future fundamental change with certainty. These people have better information and an advantage in predicting future prices. If they understand how people will perceive the fundamentals, they can predict whether stock prices will go up or down when the general market gains the information.
To make a science out of investing and predict future stock prices, we have to know what will make people pay more in the future. Some people have access to the information that helps determine this. If you don't have better information, what do you do?
Trust those that do. The people with better information act in the market by either showing their willingness to pay more or not showing a willingness to sell for less. They influence the demand and supply for a stock in a way that can create an abnormal price move in the stock. If individuals with better information act in the market, then abnormal price and volume activity are the clues of what their better information is worth.
To predict where future stock prices are going to go, you have to figure out what those with better information are doing and do the same. The only clue we have is trading activity. If someone knows good fundamental change is coming, they will either buy the stock or not sell what they own. When the perceptions of fundamentals are making an important change, the market activity tends to be abnormal in some way. Look for abnormal market activity and learn how to interpret it if you want to get closer to making trading the stock market a science.
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Stocks go up in price because investors are willing to pay more. Investors tend to buy companies that they are optimistic about, so it is important to measure whether investors are generally optimistic or pessimistic about a company. Stock charts can provide many clues about the mood of the market. For example, rising bottoms on a stock chart indicate greater enthusiasm among buyers than sellers.
The Sentiment Stockscore considers these kinds of chart pattern factors, and provides an indication of whether investors are showing optimism or pessimism. I have found that stocks that have a Sentiment Stockscore moving through 60 and rising tend to continue to rise as investor optimism carries them along.
The Sentiment Crossover Market Scan seeks stocks that have their Sentiment Stockscore crossing in to the 60 and greater zone after a lengthy period below 60. If this occurs, and the stock does not have significant overhead resistance, then there is a good potential for a future uptrend. By limiting downside potential with a stop loss point just below a short term support price, investors can better manage risk while leaving the potential for price gains.
This strategy is good for identifying longer term trades that do not require constant monitoring. The criteria are relatively simple, and a regular check of positions for an exit signal may only take a few minutes.
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1. LOUD
The LOUD chart is a good example of a trend reversal, which rarely comes with a V shaped bottom, but instead, with a gradual move from falling tops to rising bottoms. Rising bottoms are a sign of optimism and now LOUD is moving through resistance. Volume was strong today and LOUD held up well while the rest of the market was suffering. Support at $0.89.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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