Best performing stocks YTD – part 1

ddrx

vnda

dtg

car

smrt

What conclusions can we make about some of the best performing stocks:

1. Pay attention to enormous one day price expansion. Something like 20%+ one day gain. Don’t be scared by stocks that rise 50% or 100% or even more in a day. This might be the beginning of a big trend. Look between the lines. What stays behind that move.

2. The stock was neglected for a long time. It was tiny traded in tight range. Nobody cared about and as a consequence its graph looked like the EKG of a dead man.

3. There was a gigantic volume behind the sudden price growh. An all time high volume, which is 10-20 times bigger than the average daily volume for the last 100 days.

4. The initial move raises to the stock to a 6 month high. It is either neglected or it has high % of float sold short.

5. There is a clear catalyst behind the move. It is always earnings’ related. When it is not about monstrous current earnings’ growth, it is about expectations of such growth in the future.

6. Stocks move in groups. If there are other stocks from the same industry group that are also showing impressive momentum, concentrate your attention to that group. Look at all stocks in the Autoparts and coffee related industries. Such moves in whole industry groups are not caused by few grandmothers, trading their 401k. It is funds’ money behind them. And when they start buying, they do so for months. The nature of their size prevent them to acquire all stocks they want for several days or several weeks. This is why they patiently wait for slight pullbacks to rising 20 day MA to add or just start building positions in similar stocks from the same industry.

7. Momentum works – screen for the top 30 best performing stocks for the last 3 months. When you notice in your list, several members from the same industry, concentrate your efforts there.

8. Market always provides plenty of opportunities to make money on the long side. Even in one of the worst year in the recent financial history of the world – 2008, there were opportunities. During the first 6 months of 2008, while everyone complained about the high price of milk and gas, smart investors made fortunes riding stocks from the basic materials and energy sectors. I remember how in April and May of 08, some small cap, highly speculative oil stocks doubled every two weeks or so. The experienced investors know that every trend ends some day and this is why they always have an exit plan in mind.  They didn’t hesitate to exit their positions in July, when market action told them to do so and to go on a long vacation until the market told them that it’s time to come back. I know that it sounds much easier that it actually is. Let it be no confusion – trading/investing is the hardest way to make a buck in life and it offers everyone what he/she deserves. The purpose of this last paragraph is not ot motivate or scare, but to point out that most of us overtrade  and don’t concentrate efforts on a single market approach that has proven its validity and that suits our skills.

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.