Ask Yourselves These Before Buying a Stock
Stockscores.com Perspectives for the week ending December 17, 2012
| The Mindless Investor |
The Mindless Investor
New book from Stockscores founder Tyler Bollhorn
|
|
In this week's issue:
Order the Mindless Investor book now
Tyler Bollhorn's new book, "The Mindless Investor" is not yet in stores but you can now order advanced copies of it. To do so, first log in to Stockscores.com and then cut and paste this link in to the address bar of your browser. Doing so will add the charge ($29.95 + $6.50 shipping) to your shopping cart so you can complete the transaction.
https://www.stockscores.com/cart.asp?caction=add&prodid=2254
Stockscores Market Minutes Video
Will 2013 be a good year for the stock market? This week's Stockscores Market Minutes video provides some long term analysis and an important indicator to watch for the first part of January. Watch it by clicking here. To receive email alerts any time I upload a new video, subscribe to the Stockscores channel at www.youtube.com/stockscoresdotcom.
This week's Trading Lesson
Best wishes for the holidays to all the users of Stockscores.com!
It is sometimes difficult to know where to begin when deciding whether a stock is worth purchasing or not. Here are 7 questions that I think everyone should ask before buying a stock, as well as what I look for when answering the questions.
1. Are conditions right for this stock to go up?
Stocks go up because investors are optimistic about the future for the company. This is shown on a stock chart in a number of ways. The most important and easiest way is to look for whether the bottoms on the stock chart are rising. That means that the buyers are in control of the market, making the stock more likely to go higher than lower.
However, it can also happen that conditions are right for a stock to go up if the tops are falling if investors are motivated by fear. When investors are afraid of prices going lower they will sell with emotion and accept too low of a price. When stock's in this situation find a catalyst for emotional change, they often bounce back quickly.
It is more difficult to identify stocks that are likely to bounce back from oversold conditions so it is best for most investors to simply look for stocks that have rising bottoms on the stock chart. At Stockscores, we have developed the Sentiment Stockscore to also help with answering this question. If the Sentiment Stockscore is above 60, investors are likely optimistic about the company.
2. Do investors perceive significant fundamental change may be likely in the future?
It is important to realize that stocks do not go up because of what happened in the past. They go up because of what will happen in the future. We also need to accept that the stock market is not fair and that some people have better access to information than others. These investors will create abnormal trading activity in a stock when they expect significant fundamental change in the future. To beat the market, we have to leverage this break down in market efficiency and focus on stocks that are showing abnormal trading activity. At Stockscores, we use the Signal Stockscore and a break above 80 of this indicator as a signal that the stock may be trading with abnormal price or volume behavior.
3. Is the probability of the stock going higher strong enough to justify the trade?
While the market may be showing optimism, as evidenced by rising bottoms on the stock chart, we also need to know that the probability that the optimism will continue is good enough to justify entering the stock. The best way to determine this is by using chart pattern recognition. Patterns like ascending triangles, pennants, flags and cup and handles are predictive so it is essential to learn how to recognize them. Often, investors will buy a stock that is well in to an upward trend because the stock is showing a lot of optimism. However, because stocks that have been trending higher don't usually have good chart patterns any longer, they may not be worth entering. We want to find stocks that are starting upward trends so that we can maximize the probability of success. Understanding chart patterns is taught in the Stockscores StockSchool Pro course.
4. Does the reward potential of the trade justify the risk?
All signs may indicate that the stock is likely to go up but if there is a limit to how high it can go then we should evaluate whether the reward potential is significant enough to justify the trade. Stock's will often stall at historic ceiling prices which chart readers call resistance. We should exit a trade if the stock falls below its historic floor price, which chart readers call support. If resistance is not twice as far away from your entry price as support is, the trade is probably not worth taking.
5. Can you, the investor, handle the risk of the trade?
The greatest enemy of any trader is emotion. Emotion causes us to avoid taking losses when the market tells us the stock is likely to go lower. It causes us to sell our strong stocks to early. Emotion is at the root of almost every break down in our trading discipline and it is the reason most people fail to beat the stock market. If you take more risk than you are comfortable with on any trade you will likely make emotional mistakes. Therefore, it is essential that you are comfortable with the risk of every trade you make. To be successful, you must not care about the money.
6. Is the overall market condition right for your trade?
Every stock has some correlation to the overall market. No matter how good your analysis or disciplined your trading, you will do better if you go with that thing that is out of your control. Trade with the mood of the overall market and buy stocks aggressively when the overall market is going up. Play conservatively when the overall market is going down.
7. Does the stock have enough liquidity to justify the trade?
The public listing of a stock does not mean it will be easy to buy and sell. A stock needs buyers and sellers to create the liquidity of the investment. Stock's that trade with little volume or not on a regular basis are best avoided simply because the costs of entry and exit are too high.Back To Top
The Stockscores Simple Strategy
A common theme among Head and Shoulder Bottom, Ascending Triangles, Pennants and Rectangle Consolidation patterns is a break through resistance from low price volatility, usually with volume supporting the breakout. Rising price bottom formations in to the breakout point are common, but what market dynamic do these patterns really represent?
Rising bottoms are a sign of growing optimism among investors. As time passes, they demonstrate a weakening of selling force and increase power among buyers. As a stock moves up toward a resistance price point, the market is faced with the upper limit on what investors believe the company to be worth. We often see that stocks will go in to narrow trading ranges under resistance as investors come to a consensus on the value of the company. When stocks break out from this condition, they may be signaling significant new fundamental information at work in the market since resistance has been broken from strong consensus out of a period of optimism.
The Sentiment Stockscore is useful for finding optimism in the market, and the Signal Stockscore is heavily weighted on the abnormal market activity that comes with breakouts. By looking for stocks that have a Sentiment Stockscore of 60 or higher, and a Signal Stockscore of 80 or higher, we can consider charts that may have a good chart pattern set up. The Stockscores Simple Market Scan adds in some other technical filters to shorten the list of potential candidates further.
This strategy is not solely about finding stocks with good Stockscores. The most important step is visually inspecting the charts to ensure that the chart patterns are what we are looking for. A good chart pattern will have the following characteristics:
A break through resistance
Abnormal activity, in terms of price and volume activity
The break through resistance should be from a period of low price volatility. Low price volatility is characterized by the price range of trading on each day (how tall the trading range is on the chart) and by the range of trading over a number of days (are the trading days side by side on the chart, or is there a price trend?)
A show of optimism leading in to the break through resistance from low price volatility.
It is necessary to have all of these criteria, many traders forget to check whether the stock was trading with low price volatility before the breakout, or to make sure that the stock is truly breaking through resistance and will not encounter more selling pressure soon.
Back To Top
1. T.PXT
T.PXT breaks through resistance from low volatility today. Price action is abnormal but volume is not as supportive as I would like to see. The stock has good potential to go higher provided support at $5.40 is not broken.
Back To Top
2. T.SES
T.SES has broken out from an ascending triangle pattern, a good sign that the buyers are interested in pushing the stock higher. Support at $9.80.
Back To Top
3. HERO
HERO is testing long term resistance with a break higher today on abnormal volume. Has good potential as long as it can hold above support at $5.05.
Back To Top
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.
Back To Top
|
