A reader has emailed asking how can he get better results with IBD 100. In his experience he ends up buying a stock in IBD 100 after it is added and many time finds it reverses on him. This is most common experience of some of the new users of IBD 100. Many give up in frustration. To use a list like IBD 100 to trade one must understand the logic and methodology used in selecting those stocks.
IBD 100 uses IBD's proprietary EPS and RS strength rating to arrive at top 100 stocks. What it means is these stocks currently are amongst top 2-3% stocks in terms of their earnings growth trends and price growth trends. IBD also uses a price cutoffs of 12 dollar plus. The list is published weekly so there is a 7 days lag by the time changes get reflected.
As the list is based on relative strength and in fact relative strength is what determines which stock will come in the list. So for example a stock rated 99 on EPS does not become a member of IBD 100 unless it has top 3% relative strength, this means the stocks have run a lot by the time they appear in the list. That is not a problem, because you want to buy what is favored by market. The other reason to buy from the list is because it is very popular and as a result breakouts in this list work very well and have follow through. So for short term swing trades one can use it very effectively.
To do that you have to use a month or a 10 day weakness filter. A stocks which is up 10% plus in a month from the list or run up more than 10% in ten days may not be the best buy. It has a high probability of reverting or pulling back or consolidating. For example CRNT which appeared in the list at top last week was up more than 10% in ten days before last Monday, those who bought on that day suffered nasty reversal in few days.
To avoid such stocks I use two kinds of filters on a list like this:
(100 * (C1 - C22) / C22)<=10 and/ or (100 * (C1 - c11) / c11)<=10 What the filter does is finds stocks amongst this list which have had a small consolidation or pullback in last 20 or 10 days. Now when these stocks have a breakout of 2 % or more on higher volume if you enter you catch a possible start of new uptrend, it allows you to put stop at a logical consolidation area. The reason the weakness is good is because one is trying to trade a swing in a strongly trending stock as indicated by relative strength. While one wants to get in to a trending stock, one does not want to enter during trend period but enter during trend pause. That way if our entry is successful we will catch start of a new swing in trend.
Objective of swing trading is to try and trade only the trending period and avoid the non trend period. A 2% or more breakout after 10 % or less weakness indicates probable start of new swing. If our entry is successful we would have a profitable trade.
Problem with entering mid trend (when one month price growth is more than 10%) is that your entry might be too late in swing, it might turn in to non trending period. The other reason to do it is , if you study relative strength, you will find long term relative strength (1 year or more) is good , but short term relative strength (of a month) ofter leads to reversal. So stock tend to mean revert on smaller time frames.
In short we want to enter a trading vehicle moving at 100 miles per hour (which is what the IBD100 is), but we want to enter it when it slows down a bit , before accelerating again. Now all this is for those who want to use it as swing trading vehicle,. In my experience it is best for capturing such 10 or 20% swings. If you are very short term trader looking for smaller swing, one can use 5 day 2% or less price growth filter.For best results one must anticipate the breakouts in the list after applying the weakness filter.