Many unsuccessful and frustrated traders do not have market perspective. So they flirt from ideas to ideas and claim, this does not work, that does not work.
If anyone spends enough time to understand the market, ultimately they will understand that there are three basic major approaches to making money in the market: growth investing, value investing, and momentum investing.
If you base your strategy on any one of these basic approaches you will make money.
Once you select a basic approach like say growth investing or value investing then to make it work you might use variety of tactics like entering on a chart pattern , or using a indicator like MACD, or stochastic.
But most people start their trading at the tactical end. They start trading using MACD or chart pattern, or 50 day moving average, or 2 periods RSI without having a basic strategy.
The sooner you get your basic strategy right, sooner you will be successful. Because once you decide a approach you can focus all your learnings on that narrowed approach.
Growth investing and momentum investing is more suitable for smaller investor as it allows you to make above average returns in shorter period of time. Value investing might be safer but value stocks seldom make big moves.
When told this many traders ask but how did Buffett a value investor became the richest person using value investing. There are two reason why Buffett earned his billions: first he got access to significant leverage when he bought a insurance company very early in his career (he basically invests the float generated by his insurance business which gives him tremendous leverage), and second is by avoiding to pay taxes by holding stocks for long term. Taxes are drag on returns. By avoiding taxes money compounds faster.
I have studied all three approaches in detail and in fact in the beginning I was very tempted by value investing and spent a year perfecting a value strategy before realizing this will not beat growth or momentum investing. One of the things about value investing is that it is intellectually very satisfying, while not much brain is involved in growth or momentum investing. The value investors are the intellectaul snobs of investing world.
Once I decided to focus on growth investing, I have done a systematic study of growth investing and momentum investing. I have studied almost every published books and research on growth investing and lot of unpulished and proprietary raesearch on growth investing, interacted with several growth investors, talked to some well known growth investors with outstanding track records, studied approaches of major growth managers.
Out of all the books on growth investing the two best are :
From a conceptual point of view the Richard Love book is best, from actual implementation of growth investing point of view the O'Neil book is better.
Investor's Business Daily is a paper dedicated to growth and momentum investing.
It provides tools, data, and methodology necessary to profit from growth investing approach.
IBD offers investors a step by step approach to identifying and trading growth stocks.
The basic idea behind IBD approach is "historical precedent analysis". What IBD has done is looked at the top 1000 biggest winners in the market beginning from where the market data is available. Then they analysed the factors which were common in these 1000 stocks. The idea is to find a stock with similar characteristics in current market. If you did the study yourself, you would also find the same thing as IBD found. In every bull market growth stocks make some of the biggest moves.
IBD basically marries fundamentals+momentum+technical analysis to arrive at buy and sell decisions on growth stocks.
It ranks stocks using earnings momentum (the EPS ratings). EPS rating is weighted average of last two quarters earnings and last 3 to 5 years earnings with recent quarters getting higher weight. The earnings ranking is based on actual EPS not on future potential.
To further narrow the growth stock universe it uses a "quality of growth" indicator called SMR rating. SMR rating looks at Sales, Margin and ROE and ranks stock in 5 groups from A to E.
The Relative Strength Rating is a price momentum rating. It is again a weighted ROC (rate of change) where recent quarter price growth is given higher weights. ( The RS line shown on IBD chart is another price momentum indicator, it is calculated by dividing stock price by S&P price, so it gives relative strength vs. S&P).
The IBD Accumulation/Distribution Rating weighs the amount of buying volume vs. selling volume in a stock over a 13-week period. (The calculation uses a moving average of price and volume data.). It is scaled from A to E.
The IBD sponsorship rating looks at stocks being bought by funds and also quality of funds buying a stock. It is again scaled from A to E.
All the above criteria used together can help you select the best growth stocks for a given time period.
The IBD Composite Rating combines all 5 ratings described above into one easy-to-use rating (EPS+RS+SMR+Acc/Dis+sponsorship+% from 52 week high). EPS and RS Rating have higher weight, and the stock's percent off its 52-week high is also included in the formula. Results are then compared to all other companies, and each company is assigned a rating from 1-99 with 99 being the best.
The IBD 200 list published every Thursday is basically a list of Top 200 stocks ranked by Composite Ratings (96 plus composite rated stocks). So it represents the 200 best growth stocks in current market environment. When you focus on these stocks, you are unlikely to miss any major growth stock in the market. It is very efficient way to quickly select best growth stock opportunities in the market.
Once I studied the IBD approach and rankings in details, it was obvious the best and easiest approach to trading growth stock was to use the IBD 200.
When you are swing trading, you want to select stocks with highest probability of outperforming the market for your chosen time frame. IBD 200 allows you to do that very easily and conveniently.
There are also many traders who do not completely understand the logic and maths behind the way IBD calculates the various ratings. I often see traders mystified by the process or attributing motives to IBD. That is clear sign of lack of understanding of the method behind the ranking. The IBD 100, IBD 200, 85-85, CANSLIM Select, etc are just pure mathematical algorithms which pick stocks which meet certain criteria.
If you have access to earnings data, you can replicate exactly same things. There are several clones of IBD in the market. Some of them have improved upon the IBD ranking methods. If you run a search with CANSLIM in Google, you will see several of them selling a subscription to variation of the same thing. Some use forward earnings to calculate the EPS ranking. Some derive one composite ranking by using a combination of EPS, Relative strength and industry sector ranking. Some have devised different rules for entry based on MACD or ADX, some have pattern based anticipation. I have studied in microscopic details all of them. Ultimately all of them enter on high volume breakout. So the IBD 200 breakout scan incorporates those learning's.
The reason to focus on the IBD 200 is at a broader level it picks stocks based on 3 main criteria EPS momentum, price momentum, and sector momentum. So these are stocks are on the move in the market for that particular time frame. That is where money is flowing. If you cannot make money from the top 200 growth stocks then anyway it is unlikely you will make money from growth investing.
At any given time, when you look at the list, you will get 4 types of stocks.
Over extended stocks:Stocks which are way extended in terms of their price and earnings cycle and may be risky to enter at this stage. Buying extended stocks is asking for trouble.
Mid Way through Rally:In these stocks the rallies started some time ago and better entries were available then. Such stocks still offer entries for swing traders.
Basing Stocks:These are stocks which have between 20 to 65 days of basing action, where price growth is below 10 % or so yet price is within 15 to 25% of recent high. These are the kind of stocks which offer the best opportunities. This is the universe to concentrate on. The IBD breakout scan we use tries to capture such stocks. Study carefully the conditions in that scan and you will understand that it only highlights breakout on stocks with 20 to 30 days consolidation/ pullback or correction. It avoids overextended stocks.
Reverting Stock:Some of the stocks are in reversal after their rally phase being over.
The IBD 100 is a much recent addition to IBD tools. It was launched in May 2003. According to IBD the companies are ranked based on superior earnings, strong price performance, and leadership within their respective industries. The exact algorithm has not been disclosed by IBD.
The IBD 85-85 list is published in Friday edition. It is a list of stocks with 85 plus EPS ratings and 85 RS ratings that are within 15% of 52 week high. This is the list that IBD investors are supposed to focus on and identify IBD chart patterns on and enter on breakout. This list is supplemented by the daily NYSE Stocks in the News and NASDAQ Stocks in the News screen. If you truly want to invest like IBD then you are supposed to focus on these three list stocks, identify good bases out of them, calculate breakout points and then enter 10 cents above breakout points on high volume breakout. That is how retail investors are supposed to ideally use the IBD.
The IBD method lays lot of stress on anticipating the breakout, because it is trying to capture the second part of a move.
If you study the IBD approach in detail, you will find that the IBD method focuses on second part of a move after earnings momentum and price momentum is established. It does not mind missing the first part of the move which happens when a stock breaks out on earnings day. That first part of the move is what Episodic Pivots tries to capture.
Many IBD kind stocks only have first part of the move and they fail on second part move breakouts. Also because IBD uses a price cut off of 12 for Nasdaq and 15 for NYSE, it often misses a big part of the move. Especially the small cap stocks can be very low priced due to neglect and when earnings growth starts showing up on such names they can make 300 to 500% move before they reach IBD cut off of 15.
IBD essentially looks for two types of opportunities:
the 20% move
the big, multi month move in what IBD terms a big leader or big stock
The 20% moves are common. The "big stocks" are rare.
The "big stocks" are what Mark Boucher calls fixed stars. these are growth stocks which continue to maintain their above average growth for several quarters or years. Such big growth stocks create new industries or new segments. For example Cisco was a big stock which created the networking industry. Similarly Home Depot created the Home Improvement category and dominated it for years. Costco created the warehouse retailing category and continues to dominate it. Apple created the digital mobile music category and continues to dominate it. Intuitive Surgical created the category of non invasive surgery and continues to dominate it. Probably currently Green Mountain Coffee is creating a entirely new category of mini brewing in coffee industry.
The approach to the :big stock: should be different from the 20% kind trading stocks. In such big stocks one should take a position and hold it till it ultimately tops out. These are the kind of stocks where one can risk big amounts. Such stocks are rare and many times it is difficult to judge whether a stock will become a category killer. So identifying such growth stocks is higher order skill.
In order to fully understand the IBD approach to growth investing, you have to get in to microscopic details of each and every steps involved in it. If you deconstruct the approach systematically, you will understand the nuances involved in it.
There are hundreds of nuances involved in executing and trading IBD approach or for that matter any approach. Those nuances are important.
Very few people get in to those kind of details. They expect to make money without much effort , that too they expect to make it quickly. That is what leads to frustration.
So you have people going around saying, oh this does not work, that does not work and then they go chasing after the new , new thing. They spend flirting from one idea to another idea till their trading account gets wiped out.
Dan Zanger in one of his interviews said he has read William O'Neil book more than 100 times and he still re reads it every now and then.
If you decide on a approach like growth, value or momentum, then it is easy to narrow down your focus.
In any field or skill area when we start out, we have lot of ignorance. There are layers and layers of ignorance.
To become skilled one must peel all those layers of ignorance. When you see a new trader or talk to new trader he has layers and layers of ignorance and unless he or she works on overcoming those layers of ignorance a progress in trading is very difficult.
This same thing applies to trading tools. So many users of Telechart have very cursory understanding of how to use it. If you overcome your ignorance about your trading tools , you will find many ways to use them effectively.
Lot of psychological issues in trading have nothing to do with psychology but more to do with ignorance.
Ignorance problems can be solved by acquiring knowledge. These are comparatively easiest problems to fix. Provided you know what you are ignorant off.If I don't understand something, I need a strategy to overcome my ignorance. It might be reading, attending courses/training program, researching .If you overcome your ignorance problem, you might encounter next set of problems. Many people cannot overcome their ignorance problem. Because they are not aware of their own knowledge and skill gaps. In such cases you are susceptible to believing anything or can be easily manipulated. The ignorance gap is big in trading because there are no structured training programs or books which will allow you to quickly overcome your ignorance gap. In fact there are more books, courses and services which actually pray on investors ignorance and lead them in to wrong direction. So overcoming ignorance is not a easy task in trading. Significant time effort and monetary investment is required if you want to overcome your ignorance gap. The first step involved in it is to identify your own knowledge gaps and then design a strategy to fill those gaps.
I have spent significant time understanding the IBD approach in microscopic detail and internalised the philosophy, the concept, the method, the step involved , as well as the nuances involved. I have read the entire Investors site in detail, read all the foot prints, read every edition of William O'Neil book, interacted with some very successful IBD style investors, studied all the clones of IBD. And after understanding that developed my own approach to achieve similar results. That is what gives me confidence and conviction in my approach and trading.
I set out to be the most knowledgeable trader I can be in growth and momentum investing , everyday I work on furthering that goal further by a inch or two . It is a never ending process.
Everyday I prepare 1 page note from IBD. 99% of my big winners have come from my IBD notes. That is why religiously I prepare a summary like this from IBD.
Many times the information is not immediately actionable but comes in handy later when the stock breaks out.
Once you know what to focus on it takes you just 20 to 30 minutes to do this.
Besides IBD newspaper subscription I have a subscription to their other services:
Note: 100/25 f 25 funds 20 to 40. If you see something like this in my notes it indicates a stock had 100% eps growth and 25% sales growth in latest quarter and float was 25 million and its fund ownership has gone up from 20 to 40 in last 4 quarters.
The Big Picture
Leaders suffer losses as market falls in to correction.
All Indexes lost 2% plus. Changes outlook to market in correction.
Winning groups were mostly medical. Relief rally as Obama
health care plan stumbles.
Look at IBD big picture analysis over last 10 to 12 days.
You would see IBD uses lot of subjectivity.
In spite of distribution days, it was not bearish till Monday.
It kept qualifying the days with explanation.
This is one of the issue with the distribution day method.
Compare that with Market Monitor signals.
Market Monitor gives you clear signals.
IBD market direction system is often late in calling correction.
Further if you think through, IBD distribution day is like a 300 plus
negative 4% breakout day on our Market Monitor.
So in other words it says if you see 4-5 300 plus days to downside in 2-3 weeks
you should be careful is what IBD says.
Leading New Issues
cyou bpi dgw mjn open swi cys mdso
There are very few IPO's coming to market and there
are hardly any compelling IPO.
In a normal bull market there are many good IPO's.
When market started rallying in 2003, in first six month number of IPO's came in
and many of them were very big winers.
Currently only LOPE and BPI look attractive.
The New America
UTHR: Two new treatments driving growth
Adcirca for pulmonary arterial hypertension (PAH:
Also will launch Tyvaso for PAH by year end
2.5 billion worldwide potential market (this is currently 300 million company)
Drug has 300 million potential
Largest Position of
funds in growth index
brcm pcp msft jpm cim slan ibm pm gs tpx ma aapl epd
nuan csco aoc wfg lkqc swn agn
no compelling growth stock in this list.
IBD Big Cap 20
none of this interests me. I look for 100/25 stocks in this list.
Currently there are no 40/25 stocks also in this.
Use RS line to study breakouts/fault
I explained what is this RS in my weekend IBD post.
If a stock has neglect of multi month it will often have RS line going sideways.
So understanding these things is critical instead of blindly following what IBD says.
In a good EP this line going sideways might be better.
It context that is important.
IBD 197 Group Ranking
Top 3 stocks from top 20 sectors+
96 plus composite rated stocks from top 20 sectors+
40/25 stocks from top 40 sectors
2500 leading stocks
fuqi gmcr lft cpla (51/26 f= 13 funds= 91 to 136) bidu
cpla not explosive earnings, but sector seems to be experiencing some rotation.
BPI (extended) and LOPE have explosive earnings.
The Big Picture
Distribution day on NYSE
Nasdaq avoids it.
The market uptrend is still intact.
Another distribution day will be required for IBD to be
cautious on market direction.
The leading stocks have held up well so far in this correction.
Chinese stocks are the leaders.
To the point
VIT: 56/42 Sees strong growth in China.
The New America
SWI: Solar winds. 40/25 f= 5 million funds=27
Network Management Software.
Low cost provider of such software. Sells product online.
Growth has actually slowed in recent 3-4 quarters.
HGSI: 35/131 f-=151 funds= 105 to 64
Lupus drug potential 2.9 billion (currently this is approx 50 million sales company
mostly from milestone payments)
Hepatitis C drug in pipeline= 2 billion potential
Could become next big biotech leaders.
Largest positions of funds
in growth index
brcm slab msft jpm cim pcp ibm pm gs ma aapl epd tpx
nuan csco aoc wfg lkqx swn agn
Black bordered stocks
Some leaders get rattled. Some get ready for battle.