Finding the Best Fish in the Stock Ocean
The ABC's of stock selection.
Choosing which stocks to trade is as critical to profitable trading as the methodology or strategy you apply to understanding broad market dynamics.
In my experience, what happens before a trade contributes to success as much as what happens during a trade. Trading success depends as much, if not more, on which stocks you're in as it does on being able to call short-term market direction. Simply put, as a short-term trader, I need to be in stocks that are moving. A major reason my Hit-and-Run strategies work is that I use them on the correct stocks.
Below, I describe the characteristics I look for in stocks. This is how I focus on a relatively small number of names among the thousands of possible stocks to trade. This is critical, as in speculation, the more you try to see, the less you see. It's imperative to focus on a small universe of stocks as they have their own personality; by studying the behavior of a select body of stocks you get to know what to expect just as you would know what to expect from an old friend.
I've created an easy-to-remember acronym that will allow you to establish a process for focusing on high-potential stocks: OCEAN.
Each letter stands for a criterion I use in stock selection.
"O" stands for observation. Speculation is largely observation -- pure and experiential. Thinking isn't necessary and often gets us in trouble.
First, I've observed that higher-priced stocks make larger moves on a daily basis than lower-priced stocks. As a short-term trader, I'm not interested in percentage moves, but in point moves. A 5% move in a $100 stock is much bigger than a 10% move in a $20 stock.
Second, look for situations in which you can put pieces together, whether multiple signals or recognizing how a long-term pattern has combined with a short-term pattern to create a better-than-average likelihood for trend continuation.
One of the most important criteria in assembling a hit list is to observe which stocks have been outperforming the rest -- which stocks have been showing superior relative strength over the intermediate- and short-term.
Two shorter-term relative strength methods I developed for identifying the right stocks to trade are intra-day relative strength (Torpedoes -- as in, damn the torpedoes, full steam ahead) and day-over-day relative strength. For example, stocks in an uptrend that stay strong as the market fails in the morning are excellent long-side candidates when the market stops going down. If market dynamics reverse, the stock often explodes. Also, stocks that remain resilient despite a strong overall market decline are interesting long candidates to keep on the radar if the market stabilizes the following day.
Another observation worth considering is whether a stock shows persistence or not. A stock closing near the top of its range benefits the short-term trader as stocks in fast moves tend to close at/near the high (or low, for down-trending stocks) of the session.
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