Trading the Right Strategy For the Market
Stockscores.com Perspectives for the week ending September 14, 2008
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In this week's issue:
Investors all seem to be searching for that magic formula that will pick out the next winning trade. This quest can seem futile; something that works great one day can lead to total failure on another. Is it the rules that are the problem or is it how they are applied?
Some have a set of rules that they apply when market conditions are right and they find great success. But, when market conditions change and the trend is no longer in their favor, the winners stop coming and they give back all of their gains. In this way, the trader makes a false correlation between their rules and the results. Throwing darts at a board works well in a bull market but when the trend reverses, even the smartest of buyers can lose money.
Others will back test a set of rules and find their winning formula, only to lose money when they apply the rules on actual trades. They struggle to understand how a set of trading rules that worked so well during their testing period fails when they put money on the line.
Although the stock market is located in the same place every day and opens and closes at the same time, smart traders realize that the market can be completely different from one day to the next. This means that it is always smart to start your analysis with an understanding of market conditions. The strategies you choose should evolve out of this understanding and, in keeping with the top down analytical approach, the stocks you finally pick to trade will fall out of the appropriate strategies.
Here is how I approach each trade that I make.
First, I work to understand the market in general. You have to trade the market you have, not the one you wish you could have. I first look at the charts of the Dow, Nasdaq, TSX and TSX venture and ask a simple question, "Who is in control of the market?" I then ask, "Is control likely to change soon?"
Looking at the trend will answer the first question quite easily. If the chart shows falling tops, then the sellers are in control. The buyers are in control if there are rising bottoms. The second question requires a bit more charting knowledge, but it still not that difficult. Trends tend to reverse at major areas of support and resistance. So, a market that is rallying in to a multi year high will probably find some selling pressure soon, and therefore, the trend is likely to reverse. A market that has run away from its trend line is trading with emotion that will likely be rationalized eventually, and we can expect the market to pull back to the trend line. A market that is breaking a trend line may also be setting up for a reversal.
Once I get an understanding of the overall market, I then look to the industry sector groups to see where the money is flowing. I prefer to look at the industry ETFs as they are something that I can buy or sell easily and the charts tend to be better to read than the index charts. I have Stockscores Watchlists populated with these ETFs, and wrote a newsletter on this subject some time ago, here is a link to that old newsletter.
With this analysis done, I will now have a good understanding of what is driving the market and where the opportunities are likely to be found. I can now pick filtering strategies that are appropriate for the market conditions.
A market that the buyers have been in control of for some time but is coming in to long term resistance is likely to top out soon. Applying the Reversal of Fortune Strategy is a good way to look for short opportunities in this situation.
If the market is in buyer control but appears to have lots of upside potential still, the Stockscores Simple will find good trading opportunities.
A market that has been falling sharply will bounce around support, so as the market nears support, considering the Hitting Floors strategy is smart.
The Strategy Timing chapter in the StockSchool Pro course goes in to this in more detail.
I have seen many traders make money over a few months and then give it all back when conditions change. They failed to realize that you have to trade the market you have, and that means adjusting your strategy for market conditions. Trading is simple when you have the right strategy, but remember that the right strategy is always changing. So too, must you.
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So, let's take the commentary above and apply it to current market conditions, starting off with a look at the major market indexes:
The Dow is in a long term downward trend but appears likely to rally higher in the near term. This rally is likely going to be short lived. Similar situation on the Nasdaq where the market has fallen in to long term support but showed signs late last week that it was going to bounce. Look for strength in the very short term. Finally, the TSX is a couple of days in to a bounce but there are probably still some gains to be made in the heavily battered commodity stocks.
So, in general the markets are weak but likely to move higher in the very short term. When I look at the individual sectors, I see the best potential for that bounce in the Mining, Materials, Technology and Energy sectors.
I think the current situation sets up well for a swing trade buys on stocks in the commodity area that are oversold (have gone down a lot recently), are near long term support and are showing some optimism on the short term time frame (15 minute intraday charts).
So, I could run the Hitting Floors strategy or I could make a strategy that fits what I am looking for. I want weak stocks, these are easiest to find by selecting a low Sentiment Stockscore (below 40). The stocks I am looking for should have fallen a lot in price recently, so I look for the Gain/Loss to be less than -25% over the last 20 days. I want stocks that are above their open, I can do this by looking for stocks with a bullish candle today. The TSX has a lot of the commodity stocks, so I can filter only for this market. Since I am swing trading, I want stocks that have good liquidity, so I can filter for stocks trading at least 500 times a day.
I created and ran this scan and got 12 stocks in the results. I looked at the 15 minute intraday charts of all of these stocks and a few stood out, they are described below:
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1. T.UEX
T.UEX is at the bottom of its downward sloping channel and due for a bounce, the intraday chart has about three days of consolidation. I would like to see a 15 minute candle close above $1.90 for the entry signal Monday.
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2. T.KCL
T.KCL is forming a rising bottom on the intraday, 15 minute chart and could rally up to $2.70 if the commodity stock turnaround continues. I would like to see a 15 minute candle close above $1.95 to trigger the trade.
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3. T.MFL
T.MFL was breaking from an intraday ascending triangle pattern on Friday and traded some pretty good volume as well, I like it on a 15 minute close above $6.25.
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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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