December 11th, 2012

Our Discipline: A Case Study in MED

As I’ve written here often, I believe the best approach for the typical individual investor is to manage their portfolios employing the following three steps: 1) a well-founded, unemotional approach to market timing, 2) the notion of industry group rotation and 3) diversification that spreads risk among a fairly large number of individual stocks (i.e., investing approximately equal amounts among stocks in the portfolio).

Put another way, the portfolio management effort down to answering the following questions: How much money should be put at risk in the stock market at any particular moment and, if new money is to be put to work, which stocks should be added to the portfolio? 

I solved the first question for myself several years ago.  I collected data back to 1963 on the daily S&P 500 Index and, by asking a series of “what-if” questions determined when it would have been better to have invested money in the market making an average return than having it sit idle on the sidelines.  Or, stated in the reverse, when would having money sit on the sidelines been better for long-term returns than had it been invested earning an average market return?  The analysis resulted in my Market Momentum Meter, an unemotional barometer of market sentiment, that allows me to shut my ears to all the media noise and hype about what they claim is “Breaking News” and focus instead on the truth about conditions conducive to momentum-driven markets over the past 50 years.  Following the Meter’s signals over the long run, investors could have avoided market crashes while still taking advantage of the bull market runs.  I can attest to the fact it helped me avoid the worst of the 2007-09 Financial Crisis Crash.

Once the Meter signals that it’s relatively “safe” to put new money to work in the market,  I use a two-step approach for finding the stocks best for carrying that risk.  I scan all stocks to find those that meet one of four different sets of criteria and, once having narrowed down the population of publicly-traded stocks, I look at their charts to find those that might have a good chance of crossing above levels that stymied their past advances (in other words, those that look like they could soon breakout across significant, long-term resistance trendlines). The first stocks to breakout are first in line as investment candidates.  The discipline requires me to sometimes be fairly active and at other times to do nothing but unemotionally watch the Portfolio run with the market or sit idle safely protected in cash.

The debate/negotiations in Washington has brought us again to a crucial market pivot point.  The Meter indicates that when market conditions look as they do today it might have been best for us to have money invested.  I have begun running those scans to begin finding those stocks that look like they’re ready to trigger Buy Points in their charts by crossing above key resistance levels.

While 75% of the stocks currently in the Portfolio show gains and 69% have outperformed the S&P 500 since their purchase, few have delivered the sort of results as has MED since its purchase last March.  I had never heard of Medifast when it dropped through one of the Scans and presented a compelling chart.  When I purchased the stock, I wrote in the Instant Alert to Members that the stock is “a product of yesterday’s Stocks-on-the-Move scan.  It has formed an inverted head-and-shoulders reversal pattern at what I hope will be the bottom of a multi-year descending wedge pattern.”  Since then, the stock has advanced 95%:

As the usual disclaimer says, “Past performance is no guarantee of future performance”.  But, I believe in the discipline and am using it today to find the next batch of stocks some of which, with some patience and luck, will hopefully deliver what turns out to be the outstanding performers over the next nine months or a year.

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October 24th, 2012

ARMH: Patience Pays Off

When the market has been as frustrating as it’s recently been, you are always on the lookout for something to reinforce your confidence and beliefs.  It came this week from an extremely surprising direction.  A stock chart that ultimately delivered on its promise.

When I purchased ARMH (ARM Holdings PLC) on February 29, I wrote to members of my Instant Alerts service that that stock “was captured in several of the previous “Stocks on the Move” scans and is a favorite of momentum traders.  The stock has been trapped in a 12-mos. consolidation pattern.  Whether you see a horizontal channel, an inverted head-and-shoulders or a cup-and-handle doesn’t really matter that much.  The point is that a breakthrough on the upside with a strong market as tailwind could lead to substantially higher prices.”

Unfortunately, that horizontal channel morphed into a descending channel or flag.  There were many times during the past eight months that I felt like I should sell the stock but I felt that, given time, the stock would come through with its promise of a strong upward push.

A large contributor to that confidence came from the favorable divergence between the stock price action and the volume trend.  As indicated in the above chart, OBV (or on-balance-volume, the running total from adding the volume on up days less the volume subtracted on down days) has continued to edge ever so slightly higher while the price fluctuated lower from the high- to low-20′s.  That divergence tends to suggest that demand for the stock has exceed supply even as the stock’s price has slipped.

This quarter, ARMH “reported a very strong quarter, coming in at $227M in revenues for the quarter against mean analyst estimates of $222M, up 20% y/y. Pre-tax profit of $108.5M was up 22% y/y.”  Was this an extraordinary earnings report and significantly improved over prior quarters?   I don’t profess to understand (nor do I really care) why the move took place at this time.  But I do believe that others who do understand the technology and care about the company’s financial performance (aka, “the Herd”) have been accumulating the stock for the past six months. That patience was rewarded by a 12-14% gain over the past two sessions.

March 2nd, 2012

Stock Picking Now Feels Like Shooting Fish in a Barrel – Chapter 2

We hear a lot today about the individual investor being frightened away from the stock market.  We hear that the young, those who face the challenge of having to replace social security for their retirement have no interest in owning stocks.  Many today believe that owning stocks is risky, difficult and is nothing more than gambling.

However, the performance of the market and of individual stocks since the beginning of the year should have been an excellent testament to exactly the opposite.  Over the past several of months, I often feel as I did on July 23, 2009 when I wrote Stock Picking Now Feels Like Shooting Fish in a Barrel.  You should click on the link and read the piece but, for you who are too lazy, here are some choice quotations from it:

“This is a great time to be a stock picker! You don’t hear many say this these days but it’s exactly the way I feel. The market and economy felt like they were going you know where in a hand basket on March 9. But now that seems so long ago and with the vantage of the slow, 10-month market turnaround ….. picking stocks feels almost as easy as shooting fish in a barrel …… It’s not often that you can start with a clean slate (i.e., essentially a 100% cash position) …. we have little garbage to clean out and now have the pleasant task of finding new seeds to plant ….. Many stocks have charts that closely reflect the market’s bottom reversal pattern….”

The technique I described there was the “Stocks on the Move” scan; these days I run daily and it always delivers a long list of excellent candidates.  As I wrote in 2009, the scan parameters

“Sounds complex but the results filtered out with 135 amazing stocks.  I don’t mind saying I have a hard time deciding which of these 135 I’m going to add to my portfolio but I would feel comfortable and sleep well with nearly any of them (with the caveat that the market remains constructive by crossing above the neckline by Labor Day, as I expect it will). “

I present charts of the following stocks as examples in that July 22, 2009 post.  Note that by that year-end, the four stocks were up an average of 35% (the market had risen 16.88% of the period) and up over 100% by the following year-end (market up 31.82%):

As members to Instant Alerts know, I’ve bought I’ve bought 60 stocks for my portfolio since October 24, 2011 and today 75% of them show gains (four of over 20%) while I’m confident the remaining 25% will soon also show profits.

I don’t intend to boast; I mention this only to prove the point about how easy it is to find great stock to buy in at times like these.  If you buy stocks at the beginning of a bull run and are patient enough to ride them to the end of that wave then it should be relatively easy to generate some huge gains.  On the other hand,  it almost doesn’t matter what stock you buy or how good it’s chart appears to be, you’re facing significant risks and the probability of only small rewards when the trade is near the end of a market life cycle,.

In 2009, the Market Momentum Meter had turned Bull/Green on June 24, 2009, three weeks prior to the above post and the tool I use to time the market (the relative positions of four moving averages plus the Index itself as described in Market Momentum Meter) turned Bull/Green came on November 18, 2009.  We might again be at a similar inflection point, the beginning of a new market life cycle, because  Momentum Meter turned Bull/Green on January 31, 2012 and the moving averages are only 45-60 days away from a perfect bullish alignment.

Finding stocks to buy again feels like a bounty or riches, like shooting fish in a barrel.   The “Stocks on the Move” scan is again spitting out up to 200 stocks worthy of purchase (most of my 60 trades came from that scan).  As was true in 2009, many of those stocks presented classical bullish chart patterns or potential break out situations (click on image to enlarge) including:

  • ISRG on 11/3/11
  • SCSS on 1/27/12
  • EQIX on 2/2/12

At time like these, the challenge isn’t in separating the winners from losers, it’s in putting money to work quickly enough to take advantage of the market momentum move.

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February 23rd, 2012

How Reliable is the “Stocks on the Move” Scan?

If you’ve explored this site you’ve learned that one of the benefits of a membership is access to Watchlists, lists of stocks culled from the 7000 or so publicly-traded stocks by way of scans whereby all stocks are filtered against combinations of different financial and technical parameters and by my visually scanning hundreds of stock charts for potential breakout potential.

One of my favorite scans is called “Stocks on the Move”, a filter that focuses on parameters defining outstanding fundamental operating plus strong technical performance.  I developed this scan a number of years ago while attempting to replicate similar lists published in Investors’ Business Daily.  My scan was modeled after IBD’s and frequently delivers many of the same names.

A subscriber wrote the other day asking whether I’d “performed any regression analysis to ascertain the relative predictability of these parameters?”  I had to confess I hadn’t performed any rigorous analysis and realized that I should …. for the benefit of both my subscribers and myself.

I had twice posted the results of “Stocks on the Move” scans (July 22, 2009 and March 2, 2010 ) and I made the most recent list available exclusive to subscribers on January 6, 2012.  But the question remains: on a back-tested basis how reliable were these scans?  If you had selected stocks from any of these three lists, what’s the probability that they would shown a gain? outperformed the S&P 500? would the performance be any different 100 days, 200 days, 300 days or 500 days in the future?

Some might argue that this is a limited sample but I believe it’s indicative of the potency of “Stocks on the Move” as a reliable source of investment ideas with a low risk and high probability of outperforming the benchmark.  Of the 7000+ stocks the scan picked up the following stocks more than once and all together 358 different stocks:

But the question asked whether it was possible to “back-test” the scan to determine how well the stocks captured in the Stocks on the Move scan performed over various time horizons:

The back testing was performed at intervals of approximately 100 trading days after when the scans were run against 2 measures: absolute performance and performance vs. the benchmark S&P 500 Index over the same periods.  Interestingly:

  • Stocks filtered out in the scans run on both days, more than 50% of the stocks filtered out by the scan appreciated above the price on the day of the scan for 300 or more trading days into the future (of the S&P 500 Index, half perform better than the Index itself by definition).
  • More than 60% of those stocks also outperformed the S&P 500 far after the Scan was run however that better than average performance occurred primarily shortly after the scan run date; by approximately after the end of the first year, those stocks  no longer showed superior relative performance.

Become a member now and you’ll have access to the archive of all the Watchlists, the Weekly Reports, the Model Portfolios and all the Instant Alerts since November to help you navigate this market as it moves higher.

 

 

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