One of Our Preferred Strategies

We put such charts on a “watch list” and wait for them to approach their line of support.  That line of support may be a straight line like the one in the following chart, or it might be the curved line of a moving average (the broken line in the chart represents the 50-day moving average). 

We are not interested in buying the stock when it is at “B,” “D,” “F,” or “H.”  However, we are interested in buying the stock when it is at “C,” “E,” or “G.”  This particular strategy follows the advice of Jesse Livermore who said that “It is essential to make sure the lines of least resistance are in the direction of your trade before entering the trade.”  The overall momentum of the stock, as illustrated by the rising trendline and the rising moving average, increases the odds that the stock will rebound from this line of support and move to higher levels.  If the stock drops below the line, we will know it is time to sell.  Since we will not buy unless the stock is close to this line, any loss we might suffer would likely be minimal.  The person who buys at “D” or “F” will suffer a much greater loss.  A move from “D” to “E” is normal for a rising stock.  A person who buys at “D” does not have sufficient reason to sell when the stock declines to “E.”  Only if the stock were to decline significantly below its rising trendline, would a person be given a reason to sell.  Therefore, the loss for a purchaser at “D” would be equal to the decline to “E” plus the distance of the stock below “E” at the time of sale.  The loss would be far more than for the person who buys at “E.” 

The above strategy is one of the favorites of our own traders.  Sometimes we use variations on the strategy.  For example, the rising trendline might be part of the right side of a cup and handle formation or of some other formation we like to trade.  We may also use Bollinger band strategies in conjunction with it.  This pattern helps reduce and define risk.  The algorithm does not require that a stock be in an aging uptrend before listing it.  But even if it did, an aging uptrend is far more attractive than no trend.  Even aging trends have positive bias, and that is extremely helpful in a short-term trade.  Actually, a stock could be included in a “highest strength” list when it is only one-third to one-half of the way to the ultimate price for its current trend. 

Our algorithm and the RSI will both see the following types of pattern as attractive.  The RSI will see it as attractive because of the last surge in price (see inside the boxed area).  The difference between the RSI and our algorithm is that ours would not have selected the stock if it were not for the extended rise before the pullback.  The RSI would not detect the extended rise.  Obviously, this stock broke its pattern and would probably have been sold when it did so.  However, an experienced trader might then have put the stock on a “watch list” to watch for a new entry point.  This is an example of where fundamentals can come into play.  If the stock has reached its “fair value” (see the discussions on “fair value” in the section of the site pertaining to The Valuator), the stock is not as likely to climb significantly beyond its current level.  If it is still below “fair value” it could go much higher.  Of course, we would look for a signal that it “intends” to do so.  We might have bought this stock a few days ago as a swing trade, but we would not buy it at this point.  On the other hand, we might be interested again if it can climb above its previous high on convincing volume.

[It is standard practice to use the RSI to find strength in stocks because it is a cheap, quick, and easy pre-packaged upload for websites that do not have the mathematical expertise necessary to create more effective screening algorithms.   At Stock Disciplines we do our own “number-crunching,” model creation, system testing, and algorithm development.]  Sometimes the lists will resemble each other, but the RSI will often rank a stock highly even though it has a terrible chart configuration and dominating overhead resistance nearby while completely missing a stock with a much better chart pattern or even a pre-surge “setup” and more persistent strength.  Our point is that, almost without exception, other websites that list “strong” stocks use the RSI as their measuring tool.  In fact, many websites get their data from the same vendor.  Our strength algorithm is much more complex than the relatively simplistic RSI.  It is the result of our own research and effort and is definitely not a “cookie cutter” upload from a data vendor.  It is proprietary and it is not available to other websites.  It is far better at finding stocks with persistent strength than the Relative Strength Index (RSI) or other “relative strength” measurements.  For more discussion relative to our strength measurement, see the ” Strongest ETFs ” page. 

Our traders love to use this algorithm because it helps reduce risk.  That is, most of the stocks it finds have demonstrated “durable strength.”  That does not mean that they will necessarily continue to show strength, because all things and conditions eventually come to an end.  However, it does mean that they have shown evidence of a strong upward bias.  When you buy any stock, it can do only three things.  It can go up, down, or stay the same.  We believe that a strong upward bias “tilts” the outcome in our favor.  This brings us to an important consideration.  If you are looking for strong stocks, do you want a list where the stocks will all be different in a day or two or are you looking for stocks that will still be among the strongest in two or three days or even longer?  Many of the stocks on our lists will still be listed on our strongest stocks list (probably with a different ranking) after a week and others may be there after a month. 

The following list is an out-of-date example and should not be considered current.  The market had been struggling for over a month and in a fairly steep decline for nearly a week when the list was generated.  The purpose of the example is to show the layout of our reports, not to give current purchase candidates.  Stocks are listed (and numbered) in the order of their strength as assigned by our algorithm rather than according to their RSI.  Lists have been expanded from 90 to 100 stocks since the following list was created.  Subscribers click on “Subscriber Section” (second tab from top on the left) to access their reports.

Some folks who use our services have expressed a desire that stocks costing well under $5/share be included in our lists if they qualify otherwise, because such stocks often move more aggressively than more expensive stocks.  To accommodate them, for this particular list, our filter will now admit any stocks on our lists that trade at least $500,000 and 50,000 shares per day, regardless of price.  We multiply the 50-day moving average of the volume by the most recent closing price to get the average daily dollars traded.  Thus, a $1 stock might be included if it trades, by this reckoning, $5,000,000 per day and at least 50,000 shares as long as it also satisfies the requirements of our search algorithms.  That way a $5,000 investment can be made in a single stock and still represent about 1% or less of the stock’s average daily trading value.  Most of the stocks on our list will have an average trading value that is much greater than that.  Always check the size of your trade against the average value of the stock traded per day to be sure there is sufficient liquidity in the stock, especially if you want to invest more than $5,000 in a single stock and the stock trades for only a few dollars per share.  Be sure that you can move in and out of a stock quickly and without significantly altering the price of the shares.

Note: The following is an abbreviated sample.