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….
- We only use the weekly time frame, as it best captures the long-term tendency of the stock market to trend up.
- We only trade from the buy-side, as per the predominant trend.
- 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!
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.