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Issue No. 23 – April 25, 2005 Prescott, Arizona Systems@WiserTrader.com
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1.0 Trading
This issue explains how the advisories are responding to choppy market conditions in the way stocks and options are found. Our favorite trend following filters were fitted with variations to address non-trending conditions. These filters can be used with a flexible stock picking tool to independently create one’s own watch list. To reduce research efforts even further, low cost stock and options advisories are available.
1.1 Filters
Primarily the advisories use a trend following trading system taught by Dr. Stephen Cooper. This system has several parts, watch lists, a trade entry sequence and a trade exit sequence. Integral to all of these is chart analysis. Dr. Cooper describes his system in several books and CD’s. Here I will just try to give you a brief overview before explaining how they were modified for non-trending conditions.
Watch lists are created by several filters. Two stock candidate filters identify trending stocks for taking long positions based on both fundamental and technical characteristics. In order to pass the first two filters the stock must belong to a leading industry. It must have outperformed 95% of all other stocks over the past 6 months and be within a few percent of its 52 week high. The stock must also have increased its EPS by at least 80% over the past year. For the call option filter, listed as (1) in Table 1, the stock’s price should be at least $50. For the covered call writing filter, listed as (3) in Table 1, the stock’s price should be under $20. The chart for such a stock needs to show a definite up trend.
In a down or sideways market, a different filter is needed to identify candidates for put options and taking short positions. A down market filter, listed as (2) in Table 1, was created to mirror the up trending market filters as closely as possible. Stocks passing this screen must have a price greater than $30, an EPS growth of less than 20%, a 26 week percent rank relative strength less than 20% and a price within 5% of their 52 week low.
© 2005 Desert Mountain Systems, LLC. Members of wisertrader.com are neither licensed brokers nor licensed advisors. Trades discussed represent recommendations made by the editor for the wisertrader.com portfolio. The newsletter and web site are for information only and should not be considered as personal advice. While it is believed that the posted information is factual, mistakes can be made in transcription. Investors should trade stocks only after verifying all information and consulting with a licensed broker or adviser. Desert Mountain Systems markets third party trading systems but has no other affiliation with trading system companies.
Table 1
Stock Filters Used to Create Watch Lists
|
Description |
(1) Stock Candidate |
(2) Down-market |
(3) Stock Candidate |
|
Option Purpose |
Buy Calls |
Buy Puts |
Write Covered Calls |
|
Stock Purpose |
Long Positions |
Short Positions |
Long Positions |
|
Market direction |
Up, Sideways |
Down, Sideways |
Up, Sideways |
|
Price |
> $50 |
> $30 |
< $20 |
|
12 m EPS growth |
> 80% |
< 20% |
> 80% |
|
Relative Strength |
26 wk >90% |
26 wk < 20% |
26 wk >90% |
|
Price within |
5% of 52wk high |
5% of 52 wk low |
5% of 52wk high |
|
Exchanges |
NASDAQ, NYSE |
NASDAQ, NYSE |
NASDAQ, NYSE |
Trade Entry
The trade entry sequence for long positions begins with a stock that has a well defined upward trending 30 day simple moving average (SMA). Next, we look for the Williams %R to become over sold at -80 or less. This is a trigger to consider the stock for a long trade. If this has not occurred, we move on to the next stock in the list. After we get a trigger, we look for a confirmation in the form of the stock price moving above its 7 day SMA. When a confirmation is received, the stock price is moving upward and the major averages are moving upward, we enter the trade. This trading template consisting of the 30 day SMA, the Williams %R and the 7 day SMA is called a TTC-A trading template. The same template is used in a reverse fashion for taking short positions.
Trade Exit
The trade exit sequence is a bit more involved. It begins immediately after a stock is purchased and is designed to give winning stocks room to run in order to retain profits and minimize losses by taking them early. This involves the use of trailing stops and chart analysis, a very broad subject. Basically, we look at how price movements respond to support and resistance in conjunction with volume. When price falls below support on higher than average volume, a short term position would most likely be exited. A sharply rising stock making a new 52 week high may be looked to fall below its 7 period SMA in order to retain profits in a short term position. In this context, short term refers to option trades measured on daily charts. Intermediate term stock trades often are tracked using weekly charts.
Modification for Non-Trending Conditions
It is very difficult for the three filters just described to pick up new trending stocks in the present choppy, sideways market because they rely on detecting 26 week relative strength and 52 week price behavior. Two additional filters are used for the sideways market that we are in now. I call these near term filters because they only look at prices (highs, lows and relative strength) over the most recent 4 week period. These filters use a 5 day SMA to replace the 7 day SMA. Also a 20 day SMA is used to replace the 30 day SMA. All other features remain the same. These near term filters address the indecisive nature of a sideways market and are best used for quick in and out trades.
In summary, the Cooper and Down-market filters are used to pick stocks in trending markets, either up or down. In trending markets, single options are considered individually. Two additional near term filters are used to pick stocks in choppy non-trending markets. In choppy markets a put option and a call option can be considered in pairs.
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2.0 Market Analysis
Industry leadership is given in Table 2 where leading industries are ranked from highest to lowest.
Table 2