The myriad of fundamentals that influence the price of a single stock is an ongoing battle for the analyst. Fortunately, the stock market already does it perfectly for us, and announces it on a regular basis. The share price is the message of the market, and it needs to be heeded.

Now, if through a basic knowledge of price analysis we can discern sentiment towards a stock by using a simple trend definition of higher highs and lows, or lower highs and lows, then that is a very good starting point. Also, at our tails we have a naturally up-trending stock market, as well as regular cash payments from many stocks, known as dividends. Are we ahead already?

Today we present a workable trading strategy that takes advantage of the natural tendency for the stock market to trend higher, and with one clear objective – to achieve absolute returns.

WE START WITH A SIMPLE TREND DEFINITION:

Higher highs and higher lows: This simple process breaks your stocks into two groups, those that are trending up, and those that are not. If a stocks is not trending up our preferable option is to be in cash rather than in a declining equity value.

We add some general rules….

1. We only use the weekly time frame, as it best captures the long-term tendency of the stock market to trend up.
2. We only trade from the buy-side, as per the predominant trend.
3. We keep losses small and maximize the trend’s potential. We don’t sell enticed by a large profit.

Example A: Caltex

We now build some specific trading rules….

Simple entry: a stock that trades in a sequence of higher highs and higher lows has a defined up-trend.

Simple exit: a stock is disqualified when our stop is triggered.

When a stock accelerates away from a reversal level we want to protect those profits by using a “trailing stop”, but also to let the stock “breathe”. To achieve this we raise the stop/exit level to a point that achieves this delicate balance between protecting profits and greater profit potential.

Example B: Aristocrat

If our stop/exit level is triggered, it does not necessarily turn into a downtrend. It can do one of three things: trend down or go sideways, neither of which we are interested in. Or, in time, it can reverse back up, and continue its uptrend. In fact, in our naturally up-trending stock market this is often the case. So, at what point do we decide the up-trend is back in force? As this is a trending strategy we need to have a re-entry rule to recapture the trending move. We ALWAYS buy a new high – this is a basic and crucial principle. Because we have this re-entry signal it allows us to keep reasonable tight stop that is always protecting our profits.

The examples above highlight a crucial point: cut your losses quickly, and ride your winners as far as they take you.

ADDITIONAL FILTERS TO IMPROVE STOCK CANDIDATES:

There are all kinds of additional filters to reduce the number of buy signals, and improve the quality of a stock portfolio. Popular filters are yield criteria, industry groupings, market capitalization, and any number of financial metrics, such as P/E ratios. At Stockradar we use a proprietary filter we call the Trend Intensity Rating (TIR), which rates stocks trending status on a scale of +10/-10. The four ‘sentiment’ indicators used to calculate our TIR filter include: strength of the trend, volume, moving averages, and finally a measurement of momentum (crowd behaviour). These elements are weighted to reflect a diverse range of sentiment and price measures.

Ego trap: We are in the business of trading for a living. There is no right or wrong. It’s all about generating a reliable return on your investment. Picking tops and bottoms are out, and making money is in. Never fight the trend!

Conclusion…

There are dreamers and tinkerers, and then there are realists. I don’t promise the sky, and I don’t need to either, because my primary objective is steady and reliable returns that achieve absolute growth for our members. Steer clear of the snake-oil salesmen who promise 100%-plus returns a year. This is the shortest route to the poorhouse. You can approach the stock market as you might a casino. Or you can approach it as a business opportunity, so that you become “the house”. The only obstacle in your way is YOU.