Introduction to Trading
Step 1 : Boosting Success Rate through Quarterly Earnings
Step 2: Boosting Success Rate through Annual Earnings
Step 3: New Products and New Management
Step: 4 Understanding Relative Price Strength
Step 5: Institutional Investing
Step 6: Leader or Laggard?
Step 7: Market Direction
Introduction to Trading
For the last 20 years I have been trading using various methods and strategies and I could say confidently that the strategy I am about reveal is one of the most lucrative ones.
Over the years we at SMS have tweaked in the fundamental strategy to accommodate the changes like High Frequency Trading(HFT), higher volatility in the markets, and the sheer size of cash influx into the markets.
Before I jump in and explain what the 7 steps are, I would like to take you a few feet higher to outline what the strategy is and where it fits into your money making share market investing.
At a very high level, your investment strategy looks like this.
As you can see to have a rock solid way of picking a stock before it takes off is the crux of your investment strategy.
So after examining thousands of stocks which have dramatically grown thousand times, and analysing what factors are common to these growth stocks this CAN SLIM method is framed to help the investors like you.
What is CAN SLIM
A stock management process derived from researching the top-performing stocks in history and identifying 7 (C-A-N-S-L-I-M) characteristics that each stock shared prior to significant price gains.
Introduced and created by distinguished investor, William O’Neil:
- Founder of the Investor’s Business Daily® newspaper
- Author of the best-selling book: “How to Make Money in Stocks.”
But why use CAN SLIM. And what are the benefits ?
CAN SLIM® Investment Program aims to provide client portfolios with the following benefits overtime:
- Lower volatility (Beta)
- Less drawdown
- Above-market returns
CAN SLIM® Investment Program is a methodical alternative to passive buy and hold strategies. Consider the following benefits for you-:
All these 7 patterns together form a cohesive winning strategy that can catapult your investment results.
It has done so for thousands of investors…
Let’s dig deeper into the first step and understand what exactly it is…
And it will do so for you!
Step 1: Boosting Success Rate through Quarterly Earnings
All public companies have an earnings report which rates their performance over a period of time.
These reports are for shareholders who understand how companies have fared financially over the given time period.
A ‘quarterly’ is filed by public companies to report their performance at the end of each financial quarter.
Most companies file these in the months of January, April, July and October.
The key metrics used to calculate quarterly earning are net income and EPS which are then weighed against the previous years’ numbers.
By careful analysis of this comparison, investors understand the financial health of the company and whether or not they must invest in the company at all.
The stocks you choose to invest in must show a relevant increase in percentage when it comes to current quarterly earnings per share……as compared to the prior year’s same quarter.
How To Incorporate Quarterly Earning Into Your Trading Strategies
Take a look at the list of 12 ‘to-do’s’ below to help you do so.
- Always buy Stocks Showing “Huge Current Earnings Increases”
- Keep in mind that there may be misleading earnings report you might fall prey to – so keep out an eye and dodge those!
- It would be advisable to compare a company’s earnings per share to the same quarter a year earlier and not to the prior quarter, to avoid any distortion resulting from seasonality.
- Make sure you do not take into account a company’s one-time gain(s) while deciding to invest. While doing so, keep an eye out to set a minimum level for your current earnings to map the increase.
- Think before investing because of a “brand name” in the market. Though they might seem like the way to go, avoid going for older and bigger companies.
- Make sure the quarterly earnings are growing for the company you are tracking. The earnings growth will indicate whether they are on a path to great stock returns.
- Along with earnings and the growth don’t forget to track the sales growth of the company too. If the sales remain stagnant and yet the earnings are growing, it may be because of temporary efficiency in their operations.
- Traders insist on mapping Sales Growth as well as Earnings growth. These measures have helped traders understand stock a lot better.
- Stocks can get into trouble due to Two Quarters of Major Earnings Deceleration. Therefore, it is important to note that you must not invest in stocks that pose such an issue.
- Consult Log-Scale Weekly Graphs before deciding to invest.
- Other than the stocks you were aiming to buy, keep an eye out about stocks which could be a potential buy.
- Always note that the Current Quarterly Earnings per share should be up a major percentage— 25% to 50% at a minimum— over the same quarter the previous year. The best companies enlisted in the stock market can show earnings up 100% to 500% or sometimes even more.
Step 2: Boosting Success Rate through Annual Earnings
- In case of annual earnings, make sure that the stocks you have possess 25% to 50% or Higher Annual Earnings
- While dealing with annual earnings, it is important to keep an eye for a plausible big return on Equity.
- Before you make up your mind about investing in a stock, make sure you check the stability of the Company’s Three-Year Earnings record.
- An EPS rating is one of the many measures through which we can check the strength and vitality of a stock.
The EPS Rating measures a company’s two most recent quarters of earnings growth against the same quarters the year before and examines its growth rate over the last three years.
The results received are then compared with those of all other publicly traded companies and rated on a scale ranging from 1 to 99, with 99 being best. In case an EPS Rating of 99 comes up, it would mean that the company has outperformed 99% of all other companies in terms of both annual and recent quarterly earnings performance.
- The most important factor is to judge whether the rate of change in earnings is substantially increasing or decreasing.
- It is always advisable to not sell high price earning stocks short.
Step 3: New Products, New Management and New Highs : Buying at the Right Time
Why Go For the New?
It has been noticed how it takes something new to produce a startling advance in the price of a stock.
This could be a new product or a new service, which sells rapidly and causes earnings to quicken above previous rates of increase.
It could also be the new management committee in a company during the last couple of years.
This brings in the important piece of understanding that a new product comes in the form of a broom which sweeps clean the older set of thoughts – invigorating within us newer inspirations and ideas.
Therefore, such products or services bring in substantial changes within a company’s industry.
Industry wide shortages, price increases, or new technology could affect almost all members of the industry group in a positive way.
Some of the then newer products which created a sensation through the US market are:-
How To Know When to Buy During a High?
One of the greatest paradoxes hounding the stock market since its inception years is the idea that what seems too high and risky to the majority usually goes higher and what seems low and cheap usually goes lower.
Financial analysts around the world have often stated how stocks on the new-high list tend to go higher, and stocks on the new-low list tended to go lower.
In other words, a stock listed in the financial section’s new-low list of common stocks usually holds a poorer prospect, whereas a stock making the new-high list the first time during a bull market and accompanied by a big increase in trading volume might hold a better prospect most traders would want to be a part of.
Most decisive investors believe that they should be out of a stock long before it appears on the new-low list.
So, when would be the right time to begin buying a particular stock?
Most seasoned traders would tell you that the best time to begin investing in a stock would be when a stock is making or is close to a new high in price after undergoing a price correction and consolidation.
The consolidation (also known as the base-building period) in price could normally last anywhere from seven or eight weeks up to fifteen months.
As the stock emerges from its price adjustment phase, it is often found to slowly resume an uptrend, and approach a new high ground.
Contrary to how we might understand the situation, this is considered to be the best time to buy a particular stock.
One must remember that a stock should be bought just as it’s starting to break out of its price base.
Therefore, always go for the dynamic, newer innovative companies who are a bundle of future potential.
Always search for companies that have a key new product or service, new management, or changes in conditions in their industry.
More importantly, cooperations whose stocks are emerging from price consolidation patterns and are close to, or are actually touching new highs in prices would usually be your best buy candidates.
Step 4: Supply Demand of the Stock
Understanding Relative Price Strength
Relative Price Strength can be defined as, “The Price Relative indicator compares the performance of one security to another with a ratio chart.
This indicator is also known as the Relative Strength indicator or sometimes the Relative Strength Comparative.
Often, the Price Relative indicator is used to compare the performance of a stock against a benchmark index, such as the S&P 500.
Chartists can also use the Price Relative to compare the performance of a stock to its sector or industry group.
This makes it possible to determine if a stock is leading or lagging its peers.
The Price Relative indicator can also be used to find stocks that are holding up better during a broad market decline or showing weakness during a broad market advance.”
Traders around the world use Relative Price Strength to analyze which stocks are trending in the market.
The proprietary RS Rating measures the price performance of a given stock against the rest of the market for the past 52 weeks.
As part of the measurement, every stock in the market is assigned a rating from 1 to 99, with 99 being best.
Relative Strength Rating of 99 would mean that the stock has outperformed 99% of all other companies in terms of price performance.
Relative Strength of 50 means that half of all other stocks have fared better and the other half have fared comparatively worse.
From the early 1950s through 2008, the average RS Rating of the best-performing stocks before their major run-ups was 87.
In other words, the best stocks were already doing better than nearly 9 out of 10 others when they were starting out on their most explosive advance yet.”
Step 5: Institutional Investing
Identify which stocks Institutions are buying and it usually shows in the volume of the stocks as Institutions buy in larger numbers.
Also when a distinguished institutional investor buys a stock other institutions follow too.
So Volume of the stock is important as any other indicator.
Institutional Investing pools together funds through investors into various different financial instruments and assets.
These investors are known to control a significant amount of financial assets in the United States of America and have an excellent hold over all the markets.
There are several factors which contribute in the functionality of Institutional Investing.
Below, we would be discussing each of these factors.
The influence of institutional investing has increased over time and this can be noted through the concentrated ownership of institutional investors in the equity of the top 50 publicly traded corporations.
As the size and importance of these institutions steadily rise, their relative holdings and influence on the financial markets also has a grave impact.
Advantages associated with Institutional Investing
Mostly Institutional Investors are considered to be more adept at investing due to the professional operations they indulge in and the higher level of access they have to companies as well as business managements.
Nevertheless, these advantages may have disintegrated over the years as information has become more transparent and accessible, and regulation has limited the amount and method of disclosure by public companies.
Different types of Institutional Investors
Institutional investors usually invest for other people.
They are the pension funds, mutual funds, money managers, insurance companies, investment banks, commercial trusts, endowment funds, hedge funds, and some hedge fund investors.
Institutional investors account for half of the volume of trades on the New York Stock Exchange.
They deal with huge chunks of shares and as mentioned before, have tremendous influence on all market movements.
Institutional investors are usually considered to be extremely knowledgeable about market investments and are therefore assumed to make fewer mistakes.
There are different types of institutional investors and they are differentiated on the basis of certain factors, which are:-
According to Investopedia.com, Institutional investors controlled $25.3 trillion, or 17.4% of all U.S. financial assets as of 12/31/2009 and this data had been provided by the Conference Board.
It has been noted that this percentage of control has been reducing over the last decade through it peaked in the year 1999 at 21.5% of total assets.
The gradual percentage decline occurred because of the massive value increase in total outstanding assets which are available for investment purposes.
By Asset Allocation
There are institutional investors who invest in assets across a varied class, like real estate, currency and other such areas.
Equities have experienced the fastest growth over the last generation, and in 1980 only 18% of all institutional assets were invested in equities.
When it comes to institutional investment, investment companies are the second largest bodies who provide professional services to banks as well as individuals looking to invest their capital.
Open end funds have the majority of assets within this group, and have experienced rapid growth over the last few decades as investing in the equity market became more popular.
Often recognized as the first open-end mutual fund to operate in the United States of America, The Massachusetts Investors Trust came into existence in the 1920s.
Others quickly followed and by 1929 there were 19 more open-end mutual funds and nearly 700 closed-end funds in the United States.
Insurance companies are also part of the institutional investment community and they control almost the same amount of funds as investment firms mentioned above.
These insurance organizations, which include property and casualty insurers as well as life insurance companies, use premiums to protect policy holders from various types of risk.
The premiums are then invested by the insurance companies to provide a source of future claims and a profit.
Amongst all others in the list, ‘Foundations’ are the smallest body of institutional investors.
These foundations are typically funded for purely humanitarian purposes.
These organizations are typically created by wealthy families or organizations and are always dedicated to a specific public purpose.
Foundations are usually created for the purpose of improving the quality of public services such as accessibility to education funding, health care and research grants.
An example of such a foundation would be the Bill and Melinda Gates Foundation which is touted to be the largest foundation in the United States of America.
It held $36.7 billion in assets at the end of 2010.
Step 6: Leader or Laggard?
A leader stock is the market leader.
They are the number one in their space.
They carve out a nice place in the industry and they lead that.
Laggard is a financial stock or security that is under-performing.
A stock is termed “laggard” when it shows lower-than-average returns compared to the rest of the market.
In several cases, the term is used for companies or individuals within a company who might be under-performing.
A laggard is the opposite of a “leader” stock.
The “leader” stock usually outperforms the market expectations and is usually the most sought after stocks in the market.
Laggard Stocks and Sympathy Moves – Is It The Right Way To Go?
Have you heard the word InfraCaninoPhile.
It means love of the underdog.
We all have this tendency to root for the underdog, to love someone who is not the main contender.
There is a sense of heroism in going with the underdog.
Don’t do that in stock market.
In the stock market, history tends to repeat itself rather often.
Keeping this factor in hindsight, people buy stocks they like or are familiar with, stocks they feel good about, or stocks they feel comfortable trading with- like an old friend or old shoes.
These financial securities are frequently dealt in a sentimental manner but are found to be rather slow in the market rather than being leaping leaders in the stock market.
Stocks are often bought keeping this sentimental pull in hindsight – this is always a bad decision.
Sympathy plays are stocks in the same group as a leading stock, but they show a more mediocre record and weaker price performance.
These stocks eventually attempt to move up and follow “in sympathy” the powerful price movement of the real group leader.
Mostly laggard stocks are found to fall prey to these sympathy moves.
The cheaper price rates for Laggard stocks often act like a catalyst for those who are looking to invest in cheap stocks.
But, along with the seemingly advantageous disposition of buying cheap stocks come the risk of losing more money in the future when the stock does not provide the return you had hoped it might.
Therefore, it seldom pays to invest in laggard performing stocks even if they look tantalizingly cheap.
As a shrewd investor looking to garner gains, always look for the market leader.
Step 7: Market Direction
Traders believe market is driven by two human forces – fear and greed.
Market Psychology is a phenomenon where the fear and greed which emerges out of a collective participation of traders affects the market trends.
For example, when a large number of traders are fearful about a stock falling, mostly the stock falls!
Thus, the fear of the trader comes true.
The same case can be viewed with respect to a trader’s greed as well.
In the Stock Market, changes in the price movement are often termed as trend changes.
Uptrend and Downtrend are the most commonly understood trend changes.
Terminologies like “bull market” (signifying uptrend) and “bear market” (signifying downtrend) are used to determine the direction of the market movement.
Prices can trend in any of the 3 directions –
it can continue to move in the direction of the trend, it can change to a trading range or reverse the direction of the trend.
Trend changes are usually studied through the price peaks and troughs.
Changes in the uptrend occurs when a new price peak is similar or lower than the previous price peak while downtrend occurs when new price peaks or when new troughs break the pattern of the previous peaks and troughs.
What signs must you look for to detect a market top?
On one of the days in the uptrend, the total volume for the market will increase over the preceding day’s high volume, but the stock market’s closing average will show a decrease in the upward movement, than what was seen on the previous days.
The shift from the daily high to the daily low of the market index may be a little larger than on earlier days.
The market average does not have to close down for the day, although in some instances it will do so, making it much easier to recognize the distribution as professional investors sell or liquidate stock.
Normal liquidation near the market peak will only occur on one or two days, which are part of the uptrend.
The stock market comes under distribution while it is advancing!
This is one reason so few people know how to recognize distribution (selling).
Immediately following the first selling near the top, a vacuum comes into existence where volume may subside and the market averages will sell off for perhaps four days.
The second and probably the last early chance to recognize a top reversal is when the market attempts its first rally, which it will always do after a number of days down from its highest point.”
Market direction is one of the most important factors which determine the future of an investment.
In trading and investment, most of us rely entirely on the market directions to understand when to buy or sell a particular stock.
It is important to note that you must buy stocks with proven records of significant sales and earnings growth in each of the last three years plus strong recent quarterly improvements and a high return on equity.
Always give importance to learning more about charts – on how to spot sound chart patterns and combine your new charting skill with the stocks with great earnings, sales, and return on equity.
Be a constant learner.
There are newer trading strategies and approaches which are coming up in the market every day.
It is important to keep yourself up breast about all of them.
With the changing technology, we must also mould ourselves into someone who wishes to learn and imbibe as much as possible.
Each approach can provide newer perspective and can make our trading experience a smoother one.
Buy only those stocks that have at least a few institutional sponsors with better-than-average recent performance records and that have added institutional owners in recent quarters.
The most accurate and appropriate strategy for any trading situation would be your ability to make good money from your predictions and to easily control your exposure to risk factors.
It is extremely important to remember that the crucial hold over success can be achieved only through years of experience in trading. Unfortunately, there is no easy way around this one rule.
Please note that investing in share market is not a quick rich scheme. As we always tell our clients, you have to have a cohesive winning strategy, rules to play the game, and the discipline to stick to your rules.
So is investing for years and losing money to get it right the only way for profits ? No.
Fortunately we have something called Paper Trading.
Without spending a dime in losing the market, you can practice, and hone your skills.
Also a great tools can always help you a long way.