Great Companies Great Charts - stock scanning, trailing stops, and portfolio risk reduction

The Stock Trading Range

Trading Range
Each stock trades in a range based on X amount of time. Above is a three month chart for QQQ, the nasdaq tracking stock. The range here is roughy $37.5 as slightly outside the highest high and $34 slightly under the lowest low. This range can then be use to set a buy-stop at the high to determine when to get in, and then a sell-stop at the low to get out, once in the trade. This range is different for each stock since some stocks and some industries are more volatile than others and some market conditions have increased volatility as well. The range or channel is commonly used in futures trading but less common in stock trading. It's a very useful tool for customizing buys and sells tailored to individual stocks.

Additional Trading Rules To Think About

Additional Rules
Besides the screening and selection criteria, I also follow a handful of other rules to make my trading system more robust:

Number Of Stocks Held
In my book I use the analogy that the fewer the stocks you hold, the faster you drive on the freeway. There is no right or wrong answer, but as the amount of stocks held declines, your risk greatly increases as you approach a quantity of one. As the quantity of stocks increases, you return approaches that of the index as you hold great numbers of different stock ie, you can hold all the stocks in the index and hope to beat it because you become the index. I like to say that you are driving 55mph with 12 to 15 stocks and you are driving 95mph with four to six. In the past I've held ten to twelve stock but lately have I've been working to stick in the eight to ten range. This matches my comfort level.

Best Sector
I don't believe in a best sector. I believe in diversifying and so my rule is simply "never buy two stocks in the same sector. This means that if you have ten stocks, that quates to ten sectors. This again ads stability and robustness to returns in the long run.

Logic Without Emotion
When you start to care about a stock, you make mistakes. I try never to fall in love with a stock...it's just a tool I'm buying to achieve a return. I don't buy Nike because I love their shoes and I won't buy Toyota because I drive their cars. Most stocks I barely know what the company does since that is irrevelant to me. I only care that they have great financials and great technicals. Don't buy stocks you are emotionally invested in and you will more able to stay logical and disciplined in difficult times or when the stock make difficult mores.

Release Creative Needs
Stock trading is often boring. I often think that people dat-trade out of boredom and to satisfy that vegas gambling urge. Boredom can be dangerous. I build a check-valve into my trading and allow myself to purchase one stock for reasons other than that of the mechanical system. This is a nice outlet and brings some gambling fun back into the system. I am sure it hurts overall returns, but it prevents me from wanting to fiddle with the system because I am bored...so it's more of mental insurance for system stability. I have occasionally held up to two stocks in this manner, but would advise against it. Currently I am holding two stocks in this way; both amazon and invisalign are creative purchases. ALGN is so close to my normal mechanical rules that I allowed it in. It passes most of my tests except the net profit and revenue rules. It's risky to own two stocks purchased in this manner and I would advise against it. I need to take my own advise. :) LOL I trade the creative purchase the same way as all other stocks...entering with a buy-stop and exiting with a sell-stop.

If you are enjoying these posts and would like to read with more detail on my trading philosophy, you might enjoy my book - Great Companies, Great Charts.

Looking at Three Year and Three Month Stock Charts

Three Year and Three Month Charts
Once the screener finds me a list of 100 or so possible stock picks, I then go through that list, one stock at a time, and I look at the three year and three month stock charts. I want to see them go from the bottom left to the top right, with as little fluctuation as possible (less volatility or more stability). I will look at the charts at bigcharts.com or stockcharts.com or msn money. It's most important that the three year chart is stable...you can be more lenient when judging the three month chart since in the short term, there will be increased volatility.

Here is the three month and three year stocks of APOL. This stock has a great three year and a great three month chart pattern.

bigcharts.com
apol three month
apol three year

stockcharts.com
apol three month
apol three year

moneycentral.msn.com (adjust timeframe on site)
apol three month
apol three year

If I start with 150 stocks, maybe 20-30 pass this test. With those 30, I seek the final ten or so by looking at the bar charts on the Financial Results page I spoke about earlier in the week. I want to see stable growing revenue and stable growing EPS.

I think many traders and books on trading are too short term. I look longer term for longer trends. I trade less frequently and am right more often by extending the time frame. Consider using the three month and three year charts in your trading strategy.

A Pro Level Stock Screen

A Pro-Level Screen
This is the screen I use to find great companies. I add three or rules to my simple screen and soften the 20% to 15%. The rules for this screen are:

Return On Equity.....................>=15
Net Profit Margin......................>=15
EPS Growth Year vs Year..........>=15
Revenue Growth Year vs Year...>=15
Previous Days Closing Price......>=20
Previous Days Closing Price......near 52 week high

optional
Revenue Per Employee as High As Possible

The EPS and REV growth help target the best companies faster and by adding "near 52 week high", I end up saving a lot of leg-work that I would have to do by hand. I only buy a stock when it breaks-out of its 90 day trading range. It makes sense to only consider stocks near their 52 week high to minimize the time I end up sitting on cash. The screen above produces 141 results. This is right in my range of 100-150. I occassionally add the rule that "income per employee as high as possible", but it generally does very little too the list and seems redundant. In today's screen the list was 150 results without it and 141 with it. I consider it optional.

I run this screen at MSN Money but it can be reproduced on most of the deluxe screening sites.

A Simple Stock Screen

A Simple Screen
Stock screening rules need not be complex. In fact, the less rules you have, the more robust of a system you are creating. The simplest screen I can think of would have only three rules.

Stock Price >= $20
Net Profit Margin >= 20
Return On Equity >= 20

I call that my 20|20|20 Screen. :) I want the stock price over $20 to insure that I am no where near penny stocks. I want above average profit margins and return on equity to show that the company is making great profits. Here is how this screen would go together at MSN money.

The first rule is added and if you look at the bottom you will see it produces 3,144 stocks to choose from. Adding the second rule cuts the list down to 384 stocks. Adding the third rule chops the list down to 122 prospective stocks that are worthy of futher analysis. I try to make my screens find 100 to 150 stocks. In boom times, the list gets bigger and in crash times, the list gets smaller.

Are these 122 stocks all great stocks? Hell no! Maybe a handful of them are great companies with great stocks. This is the first part of the fundamental research. Screening is a tool that saves us time; it's not a magic stock picker. This is a simplified version of the normal screen I use.

Margins and Growth

Margins and Growth
What are the characteristics of a great company? The four basic fundamental criteria I use for hunting great companies are:

Net Profit Margin
Return On Equity
Revenue Growth
EPS Growth

Strong companies have the best profit margins. This shows that management knows what they are doing and has good product. Return on Equity further reinforces the strength of a business. I want to see a business that is growing in the past and exhibits signs that the growth is stable and should continue into the future. Generally I like to see a 15% or better net profit margin and return on equity. With Revenue and EPS growth I don't always hunt for an exact figure, but more importantly want to see steady stable growth. These are the fundamental research factors that I personally use to evaluate companies after screening. I do the majority of this research at MSN Money in the financial results section. This is a preview of things to come after I go deeper into screening in the next few days.

The Four Quadrant Grid

The Four Quadrant Grid
Above is a the grid I show in the first chapter of my boom. This grid is the basis for my stock picking criteria. There are many ways to analyze companies and their stock performance. Often the financial information is referred to as fundamental research and the stock price charts are called technical research. I place these two criteria on the axis. From this you can seperate firms into four categories:

Weak Companies With Weak Charts
Weak Companies With Great Charts
Great Companies With Weak Charts
Great Companies With Great Charts

Weak Companies With Weak Charts
These are the longest of the longshots. I find many penny stocks fall into this category. These companies look bad on paper, and the stock charts are all over the place. These are 1000 to 1 long odds. These are danger. I don't want to own these stocks. I doubt there are many successful investors buying from this category.

Weak Companies With Great Charts
This is the land of the Dot-coms. You have unproven companies with high hopes. The financials are weak but the projections are rosey. The charts are rocketing up as investors believe this firm has found the cure for the common cold. Some investors might be successful in this quadrant. My guess is that less than one in ten of these stocks amounts to anything.

Great Companies With Weak Charts
These are companies with soild financial statements that have fallen out of favor temporarily. There are many successful investors that hunt for stocks here. Warren Buffet and Martin Zweig come to mind and I mention them more than once in my book. These stocks are few and far between and you also risk buying a firm that is not temporarily down, but actually sliding long term. If you are a bargain shopper, this quadrant might be of interest to you.

Great Companies With Great Charts
These are the companies with above average financials and above average chart patterns. This means that both fundamental and technical information say this stock is a winner. These are the stocks that William O'Neil and the Motley Fools search for. These are the stocks that I search for. These are where you will find the biggest winners. These stocks can be more volatile, risking sharper up and down moves.

When picking stocks, I focus my efforts of finding the Great Companies, with the Great Charts.

Stockcharts.com for Stock Charts

Stockcharts.com for Stock Charts
http://stockcharts.com/
For some reason I had been living under a rock and did not find stockcharts.com until earlier this year. Wow! Their charts are second to none. Highly customizeable, clean and efficienty, and easy to use. I bought a membership minutes after finding the site since I was so impressed. I used the charts from stockcharts.com for all the charts in my book. In Stocks and Commodities Magazine, stockcharts.com has won Best Technical Analysis Web Site three years straight! The site really is that good. You can make the simplest to the most complex charts, from tiny to giant sized. Try this site out right now! :)
http://stockcharts.com/

Press ReleaseMy press release came out today. Woohoo!
http://www.prweb.com/releases/2004/6/prwebxml131371.php

I personally find it easier write books then sell them. :D I write because I love to write and consider the book selling as a fun hobby. My plan is to detail some of the key areas of my book on this blog for the next couple month in order attract internet search engine traffic. At the same time I will be sending my book to various investment sites and magazines for review. I would like to be reviewed and tested by the AAII American Association of Individual Investors. I like the way they continually test the theories of various authors. I would like to go head to head with The Motley Fools, O'Neil, and Zweig. They are the investors I look up to, and would like to compete with.

Bigcharts.com Stock Charts

Bigcharts.com Stock Charts
http://bigcharts.marketwatch.com
BigCharts.com is an excellent source for stock charts. The charts default to open, close, low, high graphs, which I prefer to charts with only the closing price. You can set up custom quick charts with your favorite settings. I use the custom page once a week when I take a look at my stocks and adjust my sell stops. Bigcharts.com offers excellent charting; give them a try today.

MSN Money Stock Screener

MSN Money Stock Screener
This is my very favorite stock screener and it's the one I use every day. Before the dot com boom, this site was $5 a month. It's now free. I would pay $29 a month for these features...I can't believe MSN money offers so many great research tools. This is where I track my portfolio as well. When you first click on the MSN Money Investor pages, you will be asked to download the Deluxe Tools. Say Yes. It's a very fast download and allows you to see all the great chearts.

One of the easier ways to use this screening system is with the Power Searches. These are pre-configured screens divided into Technical and Fundamental sections. Here is an example of Righteous Rockets. And here is the deluxe screen for Righteous Rockets.

You begin custom screens by clicking on the first row. This opens a menu and each item offers even more parameters to search with. You then stack as many rows of rules as you want. These are my favorite screening parameters. I like to set the result on the top right to display 100 insead of 20. There is also a middle area where you can add stocks for comparisson purposes. If you add a stock already in the screen results list, the name goes red.

The MSN Money is a 10 out of 10. I love the stock screener and I also love the way they present Financial Highlights page.. Give the MSN Money screener and investment pages a try. I think you'll be impressed.