lecture 10: Trading Strategies & Portfolio Management Flashcards
Choose the right market (security) to trade based on costs
Time consumption, opportunity costs, trading losses from learning curve – trading is a full time job!
Set up costs; computer, high speed internet, trading platform order execution, chart service.
Commission, slippage, missing orders in fast markets, errors.
Unexpected events – order entry going down.
Choose the right market (security) to trade based on personal risk tolerance
Leverage use
futures vs. stocks
going on margin
Choose the right market (security) to trade based on personal risk suitability
Based on your experience and personality.
Choose “slower” or lower risk markets when starting.
Choose the right market (security) to trade based on personal risk volatility
The more volatility the higher the potential profit but the greater the potential costs.
Choose the right market (security) to trade based on personal risk volatility
when are most profits made?
The breakout from low to high volatility is where most profits are made.
Choose the right market (security) to trade based on personal risk liquidity
Ability to transact a large number of shares without bringing about a large price change
Choose the right market (security) to trade based on personal risk liquidity
what is it dependent on?
Dependent on bid-ask size, as narrow spreads does not always guarantee liquidity
Choose the right market (security) to trade based on personal risk volume
You want issues with heavy volume that have liquidity
3 Types of trading for different time horizons when trading
- scalping
- day trading
- swing trading
scalping
Taking very small profits between bid-ask spreads and accumulating liquidity credits.
Requires time, an excellent order entry system, and experience.
Extremely short term (minutes) and fast paced.
Competition between the trader and the market makers, specialists
Day trading
Trading an issue and closing all positions by the end of the day, therefore not taking any overnight risk.
“Screen trading” by using intraday technical analysis signals.
Very short term minute and hour bars are used
Swing trading
Catching small trends or counter trends over several days or weeks.
Less experience required in comparison to day trading.
Entry and exits can be predefined using pivot points, 2 bar patterns, candle patterns, crossovers etc.
Not as short term, less time consuming
Two approaches used to select which issues for investment
- Top Down
- Bottom Up
Top Down approach
Selection starting from the type of market (stocks, bonds) → country → industry sector → security
Relative strength analysis, intermarket relationships
Bottom up approach
Security → industry sector → country
Security selection first also based relative strength and additional screening criteria
Other Measures of Relative Strength
Percentage change
Trend Slope Method
Levy method
Percentage change
Use a 6 month price change to determine relative strength.
Stocks are then sorted based on relative strength.
–> Higher decile stocks continued to be stronger for the next 3-10 months
Trend Slope Method
Calculate the slope of each stock’s price curve in percentage terms over a specified period through a linear regression
Stocks are then ranked by their slope
Levy method
First calculated the ratio of a stock’s current price / 131 trading-day moving average, he later changed to using the 6 month moving average.
Then ranks this ratio against the same ratio for all other stocks.
He concluded that relative strength is a better selection process in bull markets.
Stock screen selection methods of the Pros
Kirkpatrick
Value line
Wyckoff
O’Shaughnessy
Kirkpatrick
Calculated all relative price ratios to each other; P/S, 6 month RS.
Used a multifactor model of the above relative rankings and outperformed by 4:1 vs. the S&P 500 over the last 27 years
Value line
Analysis service that uses a proprietary relative strength ranking of 1 to 5 to rank the “timeliness of stocks”.
They also incorporate additional factors such as; earnings trends, recent earnings, earnings surprises.
Outperformance of 16:1 vs. S&P 500 since 1965.
Wyckoff
He believed stock prices were determined solely by supply & demand, and influenced by wealthy individuals and large institutional insiders.
He used many tools; bar charts, P&F charts, relative strength, volume.
He believed markets travelled in waves and calculated % price changes from wave highs and lows
O’Shaughnessy
Relative price strength was the factor that consistently beat the market. Calculated 12 month relative price strength.
Also studied factors such as; mkt cap, P/S, P/B, P/S, dividend yields, earnings, ROE and developed multi-factor investment strategies.
CANSLIM – The Fundamentals
C - Current Quarterly Earnings
+25% or more in recent quarters
Research shows earnings growth is the No. 1 indicator of a stock’s potential to make big gains.
–> That’s why it’s important to look for stocks with strong current results, as well as history of solid earnings growth
CANSLIM – The Fundamentals
A- Annual Earnings
25% or more in each of the past three years
CANSLIM – The Fundamentals
N - New Product, Management, Highs
Explosive stock growth doesn’t happen by accident. The biggest stock winners hadnewproducts,newmanagement ornewconditions in an industry that propelled the company to astounding height
Some investors pass over a great stock because it’s already reaching a new price high. But that’s precisely the point where many of the best stocks gain steam and begin their biggest price moves!
CANSLIM – The Fundamentals
Supply and Demand
The most basic economic principles is the law of supply and demand and one of the places its power is most sharply demonstrated is in the stock market.
Strong demand for a limited supply of available shares will push a stock’s price up. On the flip side, an oversupply of shares and weak demand will cause the price to sag.
CANSLIM – The Fundamentals
L - Leaders: Choosing To Win
Steer clear of stocks that are laggards. In the stock market, that sad-looking stock at the bottom of the pack often just falls further behind the leaders
But when you choose stocks that have solid fundamental characteristics — like earnings growth and profit margins — and are thriving in the best sectors, your prospects are better because you are selecting “institutional quality” stocks that get noticed by the biggest traders — the institutional investors like mutual fund and pension fund managers
CANSLIM – The Fundamentals
I Institutional Sponsorship
Big institutional investors, like mutual funds, hedge funds, banks and insurance companies, are the driving force behind much of the trading activity in the stock market
CANSLIM – The Fundamentals
M - Market Direction
Buying a stock during a market downturn can be like trying to swim against the ocean tide: You might make some progress, but the going will be tough, and a big enough wave of selling could drown you
