S&P 500: AVERAGE MONTHLY TOTAL RETURN

 sp-500-average-monthly-return1Source: Plexus Asset Management (based on data from Prof Robert Shiller and I-Net Bridge)

Data is from Jan 1950 to Apr 2009

Prieur du Plessis recently updated a
chart on monthly stock market returns since 1950. It clearly shows that the November
through April periods have on average been superior to the May through October half of
the year.

Prieur du Plessis recently updated a chart on monthly stock market returns since 1950. It clearly shows that the November through April periods have on average been superior to the May through October half of the year. 

The difference is quite significant. As Prieur notes, the “good” six-month period shows an average return of 7.9%, while the “bad” six-month period only shows a return of 2.5%.

The effect of earnings' surprises

I have been writting and reading extensivelly on the subject of reaction to earnings’ surprises and its effect on stocks’ prices in short-term and long-term perspective. As a prove you might see my view and links in the section “How markets work” and “Trading methods”. 

About 2 years ago I got acquantant with the effect of earnings thanks to a trader named Pradeep Bonde. Today I noticed that he has a very good summary on the subject:

When a company has a earnings surprise or a miss, more are likely to follow. That is called the cockroach effect. So when you see one earnings surprise from a company more are likely to follow. That is what produces big trends. When you have one isolated company in a sector with earnings surprise, you can ignore it. But when you have so many companies in a sector coming out with surprise, take note.

Some of the most powerful and enduring trends lasting months or years are set in motion by earning acceleration or deceleration. If you look at any long term trend in stock or sector, you will find at the beginning of the trend a series of earnings surprise or acceleration. The oil stocks started showing significant earning acceleration in 2003 and the trend lasted for 4 years. The steel stocks started showing earnings surprise in 2003 that trend lasted 4 years. So when you have a sector showing earnings surprises take note.

IBD also has a good article on earnings today.  They remind us about two factors that have to be considered during earnings’ season:

1) Earnings season can provide useful clues about the general market. If there is a shift in sentiment, you will see it in the way how market reacts to earnings reports.

A bear market punishes almost all stocks. Investors are in a bad mood and they are looking for the smallest weakness in an earnings report as an excuse to sell. Bear market is built on negative thinking.

Bull market on the other side is build on positive thinking. Investors are in a good mood and they are literally looking for a reason to lift stocks’ prices. If a company misses estimates, investors will be looking for a glimps of hope: a better than expected guidance or several possitive words from the CEO are often enough to send a stock higher, despite missing expectations. And if the company reports well above the expected and raise guidance, you will see it gapping double digit the next session. Bull market rewards performance and often forgives misses. It always sees the postive angle.

2) Be aware of the risks during earnings season. Holding a stock though an earnings report can lead to pain or gain. I personally preffer to deal with a stock after it reports. In the very rare occasions I am long in front of earnings, my position is very small and I always have an option postion to protect my equity. 

 

4 types of trades

bond

Stock trading consists of 4 major types of trades.

The range-bound trade: the stock is tied in a range and will remain there until there is a significant change in the supply/demand dynamics. For this trade you fade any move to the boundaries of the range with a tight stop a little bit below/above the range. If the range is broken, you will lose small amount. It is good for scalpers with shorter trading horizon.

The breakout trade: in order to break from a range, a stock needs to experience a major shift in supply/demand. A dramatic occurrence. News or expectation of news. The news doesn’t have to be connected with the individual stock. It might be something that impacts the whole industry or market. Sudden change in participants’ confidence. Not every breakout will be caused by clear news. Often it will happen at no news at all. In any case, volume should be your tell how genuine the move is. Buy several cents above the range with a stop several cents into the range.

The reversal trade: not every breakout is genuine. Ranges are often manipulated in order to deceive market participants and free them away from their money. Again volume or more precisely the lack of volume should assist you in taking a proper decision.  Once you notice that the breakout is fake and the move exhaust itself, fade it with a target the upper boundary of the old range and stop the high of the day.

The trend trade: high-volume breakout from an extended range often starts new powerful trend. Many traders complain that they have missed a certain breakout, without realizing that if that breakout was genuine there would be multiple other opportunities to jump on board as the new trend evolves. Trend trading consist buying/adding at the dips or selling/adding at the rips. Entries on pullbacks offer a lower-risk way to participate in an established trend.

All 4 types of trades occur on different timeframes. What looks like a breakout trade on a 10 min chart might be part of a range-bound trade on a 1 day chart. Traders should specialize in one type of trade and in one timeframe, depending on their personal skills and preferences.

Dr. Brett Steenbarger on identifying ranging and trading environment

High-volume break-outs from prolonged in the time range is usually a start of a new powerful trend. The larger the volume and the longer the consolidation level prior to the break-out, the better the odds that the newly established trend will continue.

Fast moves: TRA

 

 

TRA doubled since December 08 and rose 63% for the last month, which automatically put it in my watch list. I follow closely stocks that make 50% up or down moves in a short time frame, for which I consider a month or 20 trading days. I use a liquidity filter (average daily volume above 100k) and price filter (above $2.00) in order to escape from worthless OTC stocks.

50% move in a month is unusual and there is always a strong catalyst behind it. If you understand the catalyst, then you have better chance to understand the sustainability of the move. Many traders will consider 50% move in 20 trading days insane and will blindly short. Not so fast. A good number of those stocks have strong wind behind their back and continue to rise. I have seen stocks that rise another 50 or more percent after the initial big move.

Such types of stocks move violently and it is not wise to risk more than 0.25% of your capital on them. Always use stops. If you don’t know where you will exit in case you are wrong about the move, you are very likely to fail. Know at what point you are wrong. Remember, if you use stops, you are already doing better that 90% of the traders out there.

Certainly many on the stocks that appear on my 50% moves list are bouncing from their bottom after prolonged downturn. Such bounces are usually fruit of short covering and they are not sustainable. As a result, such stocks find strong resistance as their approach their 200-day MA and provide excellent short opportunities. Watch carefully for first signs of weakening of the trend and distribution.

In the case of TRA, the stock’s fast price appreciation was driven by a takeover bid in December. Last week it reported much better than expected earnings due to strong sales, which might add more fuel to its rocket. Last Tuesday it looked that the market was expecting this report and sold off the morning earnings’ gap. As a whole the first half of last week was charackterized by weakness in the fertilizer’s industry, which was likely the main factor that sent TRA from 25 to 22, later Wednesday afternoon. The stock managed to recover most of the move in Thursday. Friday, there was sideways action on much less than the average traded volume.

As a whole, the stock has been showing some signs of distribution lately and I would not get long before it manages for clear out 25.50 on strong general market. If you try to go against the trend and short TRA, good entry would be below 24.40 with a stop at 25.30. Target is 22.00. In this case, you will risk 90 cents to make 2.40, which is almost 3:1 reward to risk ratio. It is not the best risk/reward ratio, since the stop is relatively wide: about 3.7% of the stock price.Still  3:1 is better that 1:1. It doesn’t really makes sense to risk a dollar per share in order to make a dollar per share. Such type of thinking won’t get you very far. Your goal is to be immensely profitable, when you are right and to lose a tiny part of your capital when your are wrong. Remember, many of the best traders out there are right only half of the time and often even less than that.

 Risk 0.25% of your capital. If it is 100k, you will risk $250 on that trade. 250 divided by 0.90 will give you approximately 280 shares. 280 shares * 24.40 means that this trade will engage $6832 of your trading capital.

I will try to update several times a week with new trading ideas from stocks that have appeared in my “fast moves” watch list.

Have a great trading week