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HOT STOCKS: Why Some Stocks FLY and Others DIE
2
HOT STOCKS:
WHY SOME STOCKS FLY AND OTHERS DIE
Dr.ThomasK.Carr(aka“Dr.Stoxx”)
©2017.BefriendtheTrendTrading,LLC.AllRightsReserved.
HOT STOCKS: Why Some Stocks FLY and Others DIE
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AbouttheAuthorDr.ThomasK.Carr (aka"Dr.Stoxx")hasbeenactivelytradingthemarketssince
1996followingseveralyearsofstudyingtechnicalanalysis.Heholdsadoctorate
fromOxfordUniversity and for 16 yearswas a tenuredProfessor to liberal arts
students. Among other academic publications, Dr. Carr is the author of three
bestsellingbookson trading:TrendTrading fora Living (2007)– translated into
Chinese,KoreanandJapanese–Micro-TrendTradingforDailyIncome(2010),and
Market-Neutral Trading (2014). Hismarket insightshavebeenpublished in the
WallStreetJournal,InvestorsBusinessDaily,andUSNewsandWorldReport.
Dr.Stoxxhasdevelopedover30time-tested,proprietarytradingsystemsthathave
provedtobeprofitableinalltypesofmarketconditions.Thesesystemsarebased
on the essentials of technical analysis, but also incorporate Dr. Stoxx's unique
method of assessing the financial strength of companies, event-driven price
movements,andgeneralmarkettrenddynamics.Highlyskilledasachartreader,
Dr.Stoxxpossessesanuncannyabilitytotimehisentriesandexits,oftenjustprior
tomajormarketmoves.Heservesasaprivatetradingcoach,andhismarketletters
haveover 15,000 subscribers around theworld. Hepublishes 6 daily letters, 3
weeklyletters,and1monthlyletterthroughhis3websites:
• DrStoxx.com
• DrStoxxTrading.com
• IXTHYSLetter.com
HOT STOCKS: Why Some Stocks FLY and Others DIE
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AboutDrStoxxTrading.com
DrStoxxTrading.com (an affiliate of DrStoxx.com) is a wholly owned subsidiary
service of Befriend the Trend Trading, LLC, founded by Dr. Thomas K Carr in
October, 2002. DrStoxxTrading.com serves the needs of online traders and
investorsthroughavarietyofadvisoryandtrader-trainingproducts.Thesiteoffers
twoweeklymarketletters(THEHOTSTOXXLETTERandTHEPENNYSTOXXLETTER),
premiumtradertrainingresources(manualsandwebinars),andaprivatecoaching
service.
OrderallofourTraderTrainingResources!
1. HowtoMake50%perMonthTradingStocks
2. TheAll-NewMeanReversionManual
3. HowtoReadPriceChartsLikeaPro–Level1(webinar)
4. HowtoReadPriceChartsLikeaPro–Level2(webinar)
5. TradeforaLiving:TheCompleteStocksandOptionsCourse
ImproveyourreturnswithoneofourStockPickLetters:
1. TheHOTSTOXXLetter:+159%annualreturn
2. ThePENNYSTOXXLetter:+183%annualreturn
Formoreinformationonanyofourstockpickadvisoryandtradertrainingservices,
includingtopicscoveredinthisTradingManual,emailus:[email protected].
HOT STOCKS: Why Some Stocks FLY and Others DIE
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DISCLAIMER: This publication is for educational purposes only.
DrStoxxTrading.comiswhollyownedbyBefriendTheTrendTrading,LLC.,andis
not liable in any way for losses incurred through trading by readers of this
publication. Money can and will be lost when short-term trading. The kind of
tradingsuggested in thisTradingManual involves riskofcapital loss. Individuals
applying any of the trading strategiesmentioned in thisManual are solely and
completelyresponsibleforanyandeveryoutcome.
MOMENTUMTRADING:WhySomeStocksFlyandOthersDie©2017.Allrights
reserved. This manual, or parts thereof, may not be reproduced, transmitted,
shared, or distributed in any formwithout permission fromBefriend the Trend
Trading,LLC.Exceptionsaremadeforbriefexcerptsusedinpublishedreviews.
HOT STOCKS: Why Some Stocks FLY and Others DIE
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WelcomefromDr.Stoxx!
Greetings, fellowtrader! Thankyou forbuying thisnewtradingmanual. Great
fortuneshavebeenmadeusingtheprinciplestaughtinthismanual.NicolasDarvas
famously built a $2million fortune in the 1940’s using a version of this system.
Investors Business Daily founder, William O’Neil, discovered that the best
performingstocksinanymarketwerethemomentumstocks.Imyselfusewhatis
taughtheretoregularlyfindgreatstocksfortrading.
Youwillgetthemostoutofthistradingmanualbyfollowingthefollowing4steps:
• readthemanualcarefully;
• takenotesinyourownwordstoconfirmthatyouunderstandthemanual;
• applywhatyouhavelearnedbyputtingon“virtual”or“paper”trades;
• then,andonlythen,tryputtingonafewreal-moneytrades.
ForthislaststepIstronglyrecommendyoustartsmallandgoslowly.Ifyouhave
anyquestionsaboutanythinginthismanual,oraboutanyoftheotherwaysweat
DrStoxxTrading.comhelpyoubecomeasuccessfultrader,pleasedonothesitate
toemailus:[email protected].
HOT STOCKS: Why Some Stocks FLY and Others DIE
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INTRODUCTION
Momentumhasbeendefinedasaforcethatsustainsmovementandincreasesthe
strengthofthatmovement. Thistwo-foldnatureofmomentumisseeninwhat
tradersandinvestorscall“momentumstocks”.Amomentumstockisastockthat
istradinginasustainedtrend,eitherupordown,thestrengthofwhichisexpected
toincreaseoverthenearterm.
Momentumstocks(definedmorefullybelow)areamongthemostexcitingstocks
to trade. My own research, shared in this Manual, corroborates the general
observation among traders and investors that momentum stocks produce the
greatestamountofreturnoninvestmentintheleastamountoftime.
Justhowmuchreturnispossiblewiththerightmomentumsysteminhand?Let
meshowyou.Ihavebuiltanumberofdifferentmomentumscansovertheyears.
Somecarryhigherriskthanothers.Someworkbetterinbullmarkets,somebetter
inbearmarkets.ThestrongestperformeramongtheseisoneofthesystemsInow
useforoneofourweeklyadvisoryservices–“TheHOTSTOXXLetter”.Thissystem
istrulyamazing;itshowsextremeoutperformanceinallmarketconditions.Over
arecent5yearperiod(2009-2014),usingaweeklyrebalanceperiod(explained
below),andtradingonlythetop3stocksthatcomeuponthesystem’sscanning
tool,thissystemregisteredagainofover30,000%.Thatisenoughtoturnaninitial
stakeofonly$10,000intoover$3Million!
HOT STOCKS: Why Some Stocks FLY and Others DIE
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5-yeargainsofCarr’sMomentumSystem(weeklyrebalance)
startingwithonly$10,000
Toputthatreturnindollarperspective,let’ssaythatatthebeginningofthis5-year
period (2009) you had $20,000 to invest in the market. You put half of that,
$10,000,intoarelativesafe,large-capindexfund,andtheotherhalfintothetop3
stocks of Dr. Stoxx’s Momentum Trading System, as listed in The HOT STOXX
LETTER.Fortunatelyforyou,afterthemarketsbottomedoutinMarch,2009,the
S&P500wentonastrongbullish run fromthatpoint. Over thenext5years it
gainedover170%.Thisputsyouroriginal$10,000atjustover$27,000today.That
prettygoodbyanyone’sstandards!Butwhatthenhappenedtotheother$10,000
invested with Dr. Stoxx? At the rate of return shown in our backtest, before
commissionsandtaxes,youroriginalinvestmentisnowworth,justfiveyearslater,
HOT STOCKS: Why Some Stocks FLY and Others DIE
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$3,091,235!Whenyouaddthattowhatyouearnedinyourindexfund,youwould
nowhaveatotalinvestmentportfolioofover$3,118,000beforetaxesandfees.
Thatisthepoweroftradingmomentumstocks.Itcanturnevenasmallamountof
tradingcapitalintosomethingsubstantial,anamountofmoneythatcanmakea
realdifferencetoyourstandardofliving.WehavesubscriberstoTHEHOTSTOXX
LETTERwhobegantradingwithonly$3,000,puttingonlyabout$1,000intoeach
ofthe3positions,andwithcompoundedgainsovertimetheyarenowwellinto
the5-figuresinaccountsize.
Anotherofthegreatadvantagestotradingmomentumstocksisthataslongasyou
rebalanceyourportfolioregularly,andaslongasyourmomentumsystemgetsyou
intoonlythosestocksthatareshowingstrongupwardpricestrength,youstanda
good chance of profiting even when the market takes a downturn. Forbes
magazinestatesthat,“Momentumstrategiescanhelpinvestorsbeatthemarket
and avoid market crashes (Oct. 16, 2012).” This is to say that, when handled
properly,momentumstockscanhelpyougeneratemarket-beatingprofitsinrising
bullmarketsandprotectyourprofitsmoresecurelyinvolatilemarkets.
Momentum stocks are traditionally defined by their sustained and increasing
movementinprice,eitherupordown.Momentumstockstrategies,inturn,are
thosestocktradingstrategiesthatscantheuniverseofstocksforthosemakingthe
strongestgains(orlosses)intheleastamountoftime.Theyrecommendbuying
thestrongeststocksinanygivenmarketandrotatingyourpositionsonaregular
basis.
HOT STOCKS: Why Some Stocks FLY and Others DIE
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Whiletradingmomentumstockscanbeoneofthemostrewardingapproachesto
the stockmarket, the waymost people do it is is a recipe for disaster! Most
momentumstrategiesfail!Yes,theycanhaveincrediblyprofitableseasons.There
arewindowsofopportunityfortheprice-chaserswheneveryoneisbuyingshares
inthenamesatthetopoftherelativestrengthlists.Butthoseare“specialcase”
markets;exceptionstotherule;outliers.
Here is the key to this problem: price momentum that is not sustained by
underlyingfinancialstrengthinthecompanyitselfisatargetforshortsellers.This
makesweakstocks thatareoverboughtonpricemomentumveryvulnerable to
collapse. To put this differently: any momentum strategy that relies on price
movementalone isdoomed toeventual failure. When it comes tomomentum
stocks,pricemomentumaloneisnotenough!You’llseewhatImeanshortly.
Idefinemomentumstocksdifferently.Amomentumstockinmybookisonewhich
notonlyshowsasustainedandincreasingtrendinprice,italsoshowsstrongtrends
incertainkeyfundamentalindicators.Forpricemomentumtocontinue,evenin
thenear-term,thereneedstobevalueintheunderlyingcompany,eitherrealor
perceived.Otherwisetheuptrendbecomesvulnerabletoshortsellersandprofit
takers. Thusanytradingsystemthataimstoprofitconsistentlyandsustainably
frommomentumstocksneedstogobeyondpricemovementalone.Itneedstobe
ascanbuiltonbothtechnicalandfundamentalparameters.
InthisTradingManual,Iamgoingtosharewithyoutheresultsofmy5-yearstudy
ofmomentumstocks.Iwilloutlinethekeyessentialsthatneedtogointoanyscan
HOT STOCKS: Why Some Stocks FLY and Others DIE
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youbuildasyousearchforthebestmomentumtrades.Wewillseetogetherwhat
doesanddoesnotwork.Onthebasisofthisstudy,wewillthendetailseveralvery
specificrulesthatwillhelpyoubuildyourownmomentumstockscans.
PleasenotethatthisTradingManualservesasanintroductiontoournewweekly
stockadvisoryservice,“TheHOTSTOXXLETTER,”availablebysubscriptiononlyat
DrStoxxTrading.com.Atthesamesite,youwillalsofindourcompanionservice,
“ThePENNYSTOXXLETTER”whichhasanevenmorerobustperformancehistory,
though it is also more turbulent (as expected with penny stocks). We offer a
substantialdiscountifyoupurchasebothletterstogether.
TheHOTSTOXXLETTERrecommendsthe3bestmomentumstockpickseachweek.
TheserecommendationscomefromasetofscansthatIbuiltandtested,andwhich
Icurrentlyuseformyowntrading.BecauseTheHOTSTOXXLETTERisonlyavailable
bypaidsubscription,andbecauseIusethesestrategiestofindstocksforthefamily
fundImanage,IcannotfullydisclosetheexactparametersofthescansIuse.But
youwillbeabletotakewhat istaughthereandbuildforyourselfaveryrobust
systemscanthathighlightsthebestavailablemomentumsetups.
HOT STOCKS: Why Some Stocks FLY and Others DIE
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PARTONE:RESOURCES
Thereareseveralresourcesyouwillneedtobuildthescansassuggestedinthis
TradingManual.Eachofthesetoolschargesafee.Ifyouapproachyourtradingas
a business, like I do, you can count these costs as part of your necessary
expenditures.Whenitcomestotrading,alittleinvestmentintherighttoolswill
goalongwaytowardbuildingyourprofitpotentialandearningpower.
ResearchTools
Beforewelookatscan-buildingtools,I’dlikefirsttogiveyousomerecommended
reading.WheneverIambuildinganewsystem,Iliketodobackgroundresearch
intotheindividualconceptsthatgointothesystem’sparameters.ThiswayIhave
greaterconfidencethatwhat Iamdoing isbuiltonmethodsandstrategiesthat
havebeentestedandprovedprofitablebymuchsmartermindsthanmine!
Tothisend,Icanrecommendtwogreatbookspublishedonsubjectsthatlieatthe
heartof themomentumsystem Iwill be teaching you in thisManual. It is not
necessary to have this background knowledge, but as someone who served in
highereducationforovertwentyyears,Ivaluethiskindofknowledge.Ialsoknow
asatradingcoachthatunderstandingwhyasystemworkscanreallyboostone’s
tradingconfidence.
HOT STOCKS: Why Some Stocks FLY and Others DIE
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Ithusstronglyrecommendthefollowingtwobooks:
WilliamO’Neil,HowtoMakeMoneyinStocks (McGraw-Hill,various). This isa
classicandcomesinseveraleditionsandversions.TheoneIlikebestisthe2010
edition which is subtitled, “Complete Investing System”. While O’Neil’s famed
“CAN-SLIM” system is different fromwhat we teach here, his basic concept of
buyinggrowthstocksthatarealsooutperformingthegeneralmarketisrightatthe
heartofthemomentumconceptsIteachinthisManual.
MitchZacks,AheadoftheMarket(MartinoFineBooks,2011).MitchZacksisthe
son of Dr. Len Zacks, an MIT Ph.D. in mathematics whose doctoral research
uncoveredoneofthemostpowerfulfundamentaldriversofpricemomentum:the
changesintheconsensusofanalysts’expectationsregardingacompany’sfuture
earningsprospects.ZacksInvestmentResearch,anadvisoryfirmwhoseworkIrely
ondaily,isbuiltuponthiskeyinsight.AheadoftheMarketisanexcellentprimer
ontheconcept.Wewillbeincorporatingseveralvariantsofthisconceptintoour
momentumscans.
ScanningTools
ThemomentumscanswewillbebuildinginthisTradingManualincorporateboth
fundamental and technical parameters. There are very few scanning services
availabletodaythatareabletoincorporatebothtypesofparameters.Moststock
scanning tools offer either fundamental filters alone, or technical filters alone.
Whatweneedisonethatoffersboth.Therearesomework-aroundsthatcanbe
HOT STOCKS: Why Some Stocks FLY and Others DIE
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usedtocompensate,butthemostrobustscanscanonlybebuiltwithsoftwarethat
offersbothfundamentalandtechnicalparameters.
ThethreescanningservicesIcanrecommendarethese:
www.finviz.com
Finviz.com–Thisisanexcellentservicethateverytradershouldbefamiliarwith.
It is free if you don’tmind delayed data. Otherwise, you can pay theminimal
monthlycharge,likeIdo,forreal-timedataandscanning,andadvancedtechnical
charting.
TheadvantagesofFinvizovertheothertwoservicesareitslowcost,anditsvery
user-friendlyscanningtool.Youcanalsobuildwatchlistsofstocksdirectlyfrom
yourscanswithjustacoupleclicksofthemouse.Butthesitehastwonearlyfatal
flaws: it lacks one of the fundamental filters we use to build our most robust
momentum scans, and it has no backtesting feature. Without the backtesting
feature,youwillneverreallybesurethatwhatyouarebuildingisprofitable.But
ifyouarenewtosystems-building,oraretradingonalimitedbudget,itisagreat
tooltouse.
HOT STOCKS: Why Some Stocks FLY and Others DIE
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http://woas.zacks.com/zcom/researchwizard/
ResearchWizard–ResearchWizardisadownloadedsoftwarethatissoldthrough
ZacksInvestmentResearch.Itaccessesnightly“endofday”datatogiveyoufresh
listsofstocksforthenexttradingday.Thisuser-friendlytoolhasalltheparameters
weneedtobuildrobust,profitablemomentumscans.Forthosewholiketotinker
with parameters, the ResearchWizard offers the ability to custom create scan
filters.Moreover,ithasanexcellentbacktestingtoolthatcantestyoursystemon
over17yearsofdata,includingtheabilitytotesthardstops,trailingstops,short-
onlystrategies,andmultiplestrategycomparisons.ThisisthetoolthatIusedto
buildmymostprofitablemomentumsystems.Alltheperformancedatalistedin
thisManualwerecreatedusingResearchWizard.ResearchWizardisthetoolIuse
tofindtradesforournewservice,“TheHOTSTOXXLETTER”.
Thereisacatch,however.WhiletheRWisthebesttoolIamawareofforwhatwe
aredoinghere,itisalsothemostexpensive.Thenormalcostforayear’suseof
theResearchWizardis$1800,andthatiswithlimitedbacktestingdata.Ifyouwant
thefullpackage,youwillbepaying$3,000peryear.Forsome,$150to$250per
monthisadeal-breaker.Icertainlyunderstandthat.Forthefirstfewyearsofmy
tradingcareer,Itradedonatightbudget.Itriedtokeepmyoverheadcostslowso
thatIcouldpumpasmuchasIcouldofmyprofitsbackintomyaccount.Buthere
issomegoodnews:youcangetasubstantialdiscountifyoufollowthesesteps:call
HOT STOCKS: Why Some Stocks FLY and Others DIE
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customer service at Zacks and ask for David Bright (orwhoever is in charge of
productsales),andlethimknowthatI(Dr.TomCarr,aka“DrStoxx”)recommended
theResearchWizardtoyou.Thenaskfor“thelowestpriceyouarewillingtooffer”.
Ifyouareassertiveandcounter-offer,youshouldbeabletoworkoutapricethat
bothyouandZackscanlivewith.Alternatively,Zacksdoesoffer“lifetime”access
ataone-timepayment–currentlyitis$5000--whichwouldsavesubstantiallyin
thelong-run.I’vebeenusingResearchWizardfor10yearsnowandconsideritan
indispensabletool.
http://www.aaii.com/stock-investor-pro
StockInvestorPro–Iconsiderthisproductaviablemiddlewaybetweenthecheap
but inadequate Finviz and theexpensivebut fully equippedResearchWizard. I
myselfuseitasaback-uptooltoResearchWizard.Ialsorelyonitexclusivelyfora
numberofthetradingsystemsIdescribeinmythirdbook,Market-NeutralTrading
(McGraw-Hill,2014).
Stock InvestorPro is adownloaded software that runsondataprovidedby the
AmericanAssociationof Individual Investors (www.aaii.com)whichsupports the
softwareandprovidescustomerservice.StockInvestorProhasalltheparameters
weneed,bothfundamentalandtechnical,tobuildrobustmomentumscans.While
HOT STOCKS: Why Some Stocks FLY and Others DIE
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lessuser-friendly than theprevious twoproducts, there is a setofonline video
tutorials you can view to get acquainted with its functions. And the price is
certainly on themark. An annual subscription only costs $298, but it is nearly
alwaysonsalefor$198.Atwo-yearsubscriptionlistsat$598,butthattooisusually
onsaleatonly$299.Attheseprices,StockInvestorProiscertainlyagreatvalue.
TherearetwodrawbackstoStockInvestorPro.First,itonlyworksonweeklydata,
uploadedtothesiteeachweekend.Youareautomaticallypromptedtodownload
thedataateachuseifyouarenotusingthemostcurrentupload.Thesedownloads
cantakeseveralminutes,dependingonthespeedofyourinternetconnection.The
seconddrawbacktotheproductisthatithasnobacktestingfunctionality.
WiththatImind,Istronglysuggestdoingthefollowing,especiallyifyouwantto
buildyourownmomentumscans:first,hagglewithZacksforthecheapestannual
feeyoucangetfortheResearchWizard.UsetheWizardforayear,buildingand
testingyoursystemspertheguidelinesIsetoutbelowuntilyougetasupersetof
veryrobustmomentumscans.ThencanceltheWizard,subscribetoStockInvestor
Pro,and inthatsoftwarebuildyoursupersetofscans. Thewholeprocess,not
allowingfortaxdeductions,mightputyoubackabout$2000fortheyear,butthat
isasmallpricetopayforbeingabletofindandtradesomeofthemostopportune
setupsinthemarketonaweektoweekbasis.
On the other hand, let’s hope that you make so much money trading your
momentum stocks that you are able to afford both ResearchWizard and Stock
InvestorPro!
HOT STOCKS: Why Some Stocks FLY and Others DIE
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PARTTWO:DEFINITIONS
Allstocksaretypicallydividedintotypes,dependingonthefundamentalsofthe
underlyingcompanyandhowtheirsharepricesareexpectedtobehaveincertain
typesofmarkets.Whilethefollowinglistisnotexhaustive,someofthemore
commonstocktypesarethese:
1. GROWTHSTOCKS.Agrowthstockisonethatrepresentsacompanyknown
foritsrapidgrowthofearningspershare(EPS),revenueandsalesper
share,fromquartertoquarterandyeartoyear.Growthstocksnormally
carryhigherP/Evalues,ornoP/Evalueatalliftheirearningsareinthered,
becausetheirpresentvalueliesnotinwhattheyareearningnow,butwhat
theyareexpectedtoearninthefuture.Growthstockstendtooutperform
themarketswhentheyarerising,andtendtounderperformwhenthe
marketsarefalling.
2. VALUESTOCKS.Avaluestockisonethatrepresentsacompanyknownfor
itsstrongnetincomepershare,strongsalespershare,lowpricetobook
value,andstrongfreecashflow.Valuestocksoftendispersedividendsand
carrylowP/Evalues,alongwithlowP/SalesandP/CashFlowvalues.
Generallyspeaking,valuestocksaredesirablenotsomuchfortheirfuture
earningspotentialasmuchasfortheirpastearningsrecordrelativetotheir
currentshareprice.Valuestockstendtofalloutoffavorduringstrongbull
markets,andcomebackintofavorduringweakandmorevolatilemarkets.
HOT STOCKS: Why Some Stocks FLY and Others DIE
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3. MOMENTUMSTOCKS.Amomentumstockistraditionallydefinedonthe
solebasisofmovementinitsshareprice.Amomentumstockisonein
whichthepricepershareshowssuddenandthensustainedaccelerationin
theprevailingpricetrend,whetherupordown.Butthischangeinprice
movementisnormallyaproductofchangeineitherthecompany’s
underlyingfundamentals(e.g.,anexpectedriseorfallinearnings),orinthe
perceptionofthecompanyduetosomeextrinsicchange(e.g.,acultural
shiftwhichsuddenlymakesthecompany’sproduct“hot”).Momentum
stocksareeasilyrecognizedbytheirpricechartswhichtypicallydisplay
shorttermburstsofmovementoutofanareaofpriceconsolidation,along
withasustainedtrendinthatsamedirection.Momentumstocksare
expectedtocontinueinthesamedirectionoverthenear-term,regardless
ofmarketdirection.
Mosttradersandinvestorsfocusononeofthesethreecategories.Warren
Buffett,forexample,arguablythegreatestinvestorofalltime,isa“valuestock”
guru.Hismentor,BenjaminGraham,wasalsoa“valuestock”guru.Bothmen
builttremendousrecordsoflong-termsuccess.Othershaveturnedto“growth
stocks”tobuildtheirfortunes.MartinZweigandLouisNavellierareboth
examplesofsuccessfulfundmanagerswhofocusprimarilyonstronggrowth
stocks.Thosewhochase“momentumstocks”arealsorankedamongthewinners
ofWallStreet.Theyincludefundmanager,RichardDriehaus–the“founding
father”ofmomentuminvesting–whocurrentlyoverseesa$10Bfund;andthe
infamousJesseLivermore,consideredbyarecentbiographertobe“thegreatest
HOT STOCKS: Why Some Stocks FLY and Others DIE
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traderwhoeverlived,”andwhosepersonalfortuneatonetimepeakedtonearly
$14Bintoday’smoney.Onhisowntradingstyle,Livermoresaidthisinhis
autobiography,ReminiscencesofaStockOperator:
“Whensomeofmystocktradingoperationsaregiven,youwillnoticeImademy
firsttrade…whentheforceofmovementwassostrongthatitsimplyhadtocarry
through.”
Livermore’sstatementcaptures,inessence,thegistofmomentumtrading:enter
onstrongpricemovementwiththeexpectationthatthatmovementwillcontinue
inthesamedirectionoverthenearterm.Soundsreasonabledoesn’tit?
Unfortunately,asastand-alonefilterforfindinggreattradingstocks,tradingon
strongpricemovementalonedoesNOTworkwell.Myresearchdemonstrates
thatsimplychasingpricemomentumisnotenoughtobuildawinningtrading
system.Myresearchalsoshowsthatbycombiningallthreeofourstocktypes
together,trulyamazingtradingsystemscanbecreated!
Itistothatresearchthatwenowturn.
HOT STOCKS: Why Some Stocks FLY and Others DIE
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PARTTHREE:PRICEMOMENTUMALONEISNOTENOUGH
Ihavespentoverfiveyearsresearchingmomentumstocks.Idescribethis
processinchapter2ofMarket-NeutralTrading.Myquestinitiallywastofindthe
commontechnicalpre-settothe500mostexplosivepricemovementsseenin
individualstocksovertherecentpast.Myworkingassumptionwasthatthere
wasaquantifiablefootprintinthetechnicalchartsofstocksjustpriortotheir
priceexplosion.IfIcouldisolatethisfootprint,thencodeitintoatechnicalscan,I
figuredthatIwouldhavethebesttradingsystemontheplanet!
Infact,myworkdidindeeduncoveraverycommonpatterninnearlyhalfofthe
stocksthatrosesharplyinprice.Unfortunately,Ididnotlearnofthefatalflawin
mylogicuntilItradedthesystemwithrealmoney.Afteritfailedmiserably,it
becamepainfullyapparentthatjustbecausethereisacommonpatternthat
precedesmoststrongrisesinprice,itdoesnotfollowthateverystockdisplaying
thispatternwillriseinprice.Infact,mostdon’t.Theyeithergosideways,or
down,ordownsharply.
Thissamefatallogicisatworkinmostmomentumtradingsystems.The
reasonedassumptioninmostofthesesystemsisthatstocksshowingthe
strongestshort-termgainsareprecededbystrongaccelerationinshareprice.
Thisseemsreasonablebecausemoststocksthatgoupsharplyinpricebegan
theirascentwithmarkedaccelerationinprice.Unfortunately,thisreverse-
HOT STOCKS: Why Some Stocks FLY and Others DIE
22
engineeredthesisisinextricablypairedwithaforward-lookingtruth:moststocks
thatshowstrongpriceaccelerationshortlythereafterexperiencestrongpullbacks
inprice.Thusashort-termtradingsystembasedonnear-termaccelerationsin
pricemovementaloneisdoomedtodismalfailure.
Toprovethispoint,considerthefollowingdata.Imaginethatwebuiltasimple
momentumtradingsystembasedonpricemomentumalone.Thissimple
momentumsystemcouldbecodedintoascanthatisbasedpurelyonpercentage
pricechangeoverthreedifferenttimeframes.Itmightlooksomethinglikethis:
• Price>$10pershare
• AverageVolume>100,000
• 24-week%PriceIncrease=Top#30stocks
• 12-week%PriceIncrease=Top#10stocks
• 4-week%PriceIncrease=Top#3stocks
Thisscanteasesoutfromtheuniverseofover8000stocksthe3thatrisetothe
topofthelistbasedexclusivelyonupwardpricemomentum.Asmomentum
tradingsystemsgo,thisisexactlywhatyouwant:stocksthataremovingup
stronginpriceovermiddle-rangeandnear-termtimeframes.Now,let’sbacktest
thissystemoverthepast5years,usinga4-weekrebalancingperiodandseewhat
happens.Afterall,thisiswheretherubbermeetstheroad.Ifthesystemcannot
turnaprofitoverthepast,itverylikelywillnotdowellinthefuture.
HOT STOCKS: Why Some Stocks FLY and Others DIE
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Togivemysystemeverypossibleadvantagetoshowitsstrength,Iselectedthe5
yearsthatbeganatthebottomoftherecentmarketcrash(March,2009)tothe
all-timemarkethighsthatwereprintedintheS&P500inMarch,2014.Thiswas
anespeciallybullishperiodforUSstocksastheyralliedoffthedeep-cutlows
causedby“TheGreatRecession”of2007–2008.TheS&P500rose165%during
thisperiodforacompoundedannualgrowthrateofover22%.Howdidour
“momentumstocksfare?Notverywell.Infact,theyactuallylostmoney!
Letmesaythatagain:duringwhatformanyyoungerinvestorsisthegreatestbull
markettheyhaveeverseen,oursimplemomentumstocksystemLOSTMONEY!
Thefollowinggraphicshowsthereturnsfortheabovescreenwhenusinga4-
weekrebalanceinterval:alossof-34%over5yearsvs.morethan+170%gainfor
theS&P500!Ooops!
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5yeartestofPrice-onlyMomentumScreen(Longs,4wkrebalance)
Thisclearlydemonstratesjusthow“weak”momentumstocks(representedbythe
greenline)canbe,eveninastronglybullishmarket,whenpricemomentumisthe
onlycriterionusedtofilterstocks
Normallyarobustscanwillimproveitsreturnsbyshiftingtoashorterrebalance
period. In thereturnsshownabove,wewereusinga4-weekrebalanceperiod.
Thismeansthatthescanwasrunevery4weeks,withanystocknotshowingupin
thescansoldandreplacedwithanewstockfromthescan.Perhapsbytightening
theperiodto2weeks,wecanimprovethereturns.Butwatchwhathappensnow
toourprice-onlymomentumscan:
HOT STOCKS: Why Some Stocks FLY and Others DIE
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5yeartestofPrice-onlyMomentumScreen(Longs,2wkrebalance)
Insteadofimprovingourreturns,whichiswhatweexpectfromarobustscanwhen
wetightentherebalanceperiod,wemadethemworse!Wewentfromalossof
over -34% to a loss of -71.2%! Andwhatwasworse,we saw our systemmax
drawdown for theperiod rise to -91%,whichcomparesveryunfavorably to the
S&P500,whichhadamaxdrawdownoverthesamefiveyearsofonlyaround-15%.
Soclearly,scanningforpricemomentumaloneisNOTthewaytogo!
Andyet, it isanestablishedpieceoftradingwisdomthatbuyingstocksshowing
strongpricemomentum–whatsomecall“trendfollowing”or“trendtrading”–is
aprofitableendeavor.Whatarewemissing?Toanswerthat,weneedtodosome
moreresearch.
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PARTFOUR:ADDINGFILTERS
Wecanconcludefromtheforegoingthatchasingafterpricemomentumaloneisa
recipefordisaster.Yes,the“turtletraders”andotherspeciesof“trendfollowers”
normally use systems based on price momentum alone. But the Turtles were
trading futures, not stocks. Stocks are a very different game; they abide by
differentrules.Ifanyonetellsyouheismakingmoneytradingmomentumstocks
basedonpricealone,he iseither lying,very lucky,orwillsoonsufferanervous
breakdownbecausehe’sgluedtothemonitorscalpingoutofeveryminorprice
twinge.
Yes,somecanmakeagoodlivingtradinginandoutofintradaymomentumswings.
But we are not talking about day-trading in this Manual. And you can have
incrediblyprofitablestreaksputtingonveryshort-termtradesinthebig“momo”
nameswhentheyareonthemove,andtheoverallmarketismovinginyourfavor.
Butthistradingmethodisnevermorethanaboutamonthawayfromgoingbust
onastringofbiglosses.
What we are after here is amomentum trading system supported by a set of
functionalscansthatcansustainsteady,long-termgainsoveraprofitable“trade
foraliving”kindofcareer.Wealsowanttoseethissystemminimizelossesand
evenpostdecentgainsduringweakmarketperiods.Togetthere,wewillneedto
learnhowto trademomentumstocksprofitably,because it is thebestgame in
HOT STOCKS: Why Some Stocks FLY and Others DIE
27
town.Buttotrademomentumstocksprofitably,wewillneedtolearnthekeyto
turning a losing system (trading momentum stocks based on price movement
alone)intoawinningsystem.
Hereisthekey:ourscansneedtoaccountfortherealitythatpricemomentumwill
onlybesustainedbythetradingcommunity (bothprofessionalandretail),even
overthenear-term,whenthereisrealvalueintheunderlyingcompany.Realvalue
cancomeinvariousforms,butmyresearchhasnarrowedthatrangeconsiderably.
AswewillseeinthenextpartoftheManual,onceweaddfilterstoourscanthat
factorinfundamentalvalue–i.e.valueintermsofthecompany’ssales,earnings,
growthandvaluation--wewillseeourprofitsskyrocket.
AddingaValuationFilter
Ouraimnowistofindfiltersforourscanthathelpusidentifytherealqualitystocks
amongallthosestocksthatshowmomentuminprice,i.e.thestocksthatdespite
anupwardriseinpricestilltradeatreasonablevaluationsbasedonearningsand
sales.Sowhatthenhappensifweaddavaluationfiltertoourscan?Thereare
severaldifferenttypesofvaluationfilterswecoulduse,themostcommonofwhich
istheP/Eratio(PricetoEarnings).Butsincemanyofthebestmomentumstocks
donot(yet)showrealnetearnings,andthushavenoactualP/Eratio,thisisnota
goodchoice.
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Another valuationmetric that is commonlyusedby value stock investors is the
PricetoBookValue(P/BV)ratio.IdiscussthisratioingreaterdetailinChapter7of
Market-NeutralTrading.ThereIdescribetheworkofthemainproponentofthis
ratio,Dr.JosephPiotroski,aneconomistattheUniversityofChicago.Piotroskihas
statistically demonstrated that low P/BV stocks tend to outperform high P/BV
stocks over time, and that they really outperform once other fundamental
parametersareconsidered.ButtheproblemwithusingP/BVasavaluationmetric
isthatthevastmajorityoflowP/BVstocksshowverylittlepricemomentum.This
iswhytheyhavesuchlowP/BVvalues:theirsharepricehasfallensignificantly.In
fact,mostcompaniesontheirwaytobankruptcywillspendsometimeinthelow
P/BVuniverseofstocks.
Ratherwhatweneedforourmomentumscanisavaluationratiothatincorporates
realgrowthinthecompany’sperceivedvalue.ThePEGratioworkswellforthis
(P/EdividedbyEPSGrowthRate)butsince,again,manystrongmomentumstocks
don’thaveaP/E,theydon’thaveaPEGeither.Soweneedtolookelsewhere.
Thevaluationmetric that suitsourpurposesperfectly is thePrice toSales ratio
(P/S).Thisratioislowwhenacompanyhasahighlevelofsalesrevenuenumber
ofoutstandingsharesrelativetoitspricepershare.Thissinglemetriccanbeused
tohighlightcompaniesthathaverealmomentumintheirearningspowerbecause
theyaregrowingtheirsalesrevenues(eveniftheyhavenonetincomeyet),and
are trading with relatively smaller share floats (hence are more responsive to
changesinsharedemand),andarenotyetoverlypricedrelativetothoserevenues
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29
per share. It is this universe of stocks that tend to be the real winners in the
momentumgame.
Forourpurposeshere,alowP/Smetricisanythingunder1.0.Ifyouaretrading
largecapmomentumstocks,youcanlowerthisevenfurtherto,say,0.7. AP/S
ratioof1.0meansthat thecompany isselling$1of itsproductperoutstanding
shareforevery$1initsshareprice.AnotherwayofthinkingabouttheP/Sratiois
that,ifacompanyistradingatonly0.5xsalesrevenue,thenyouareonlypaying
$0.50forevery$1.00ofsales.That’sagreatvalue!That’sthekindofstockthat
tendstocarrymomentumhigherbecausethereissomuchperceivedvalueinthe
sharesatcurrentprices.
Solet’sseewhathappenswhenweaddaP/Svaluationfiltertoourscan.Now,
with this valuation requirementadded,weendupwithamomentumscan that
lookslikethis:
• Price>$10pershare
• AverageVolume>100,000
• PricetoSalesRatio<1.0
• 24-week%PriceIncrease=Top#30stocks
• 12-week%PriceIncrease=Top#10stocks
• 4-week%PriceIncrease=Top#3stocks
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Justwatchnowwhathappenswhenwerunthisscanoverthesame5-yearperiod
weusedabove,usingthesame4-weekrebalanceperiod:
5yeartestofPrice+P/SMomentumScreen(Longs,4wkrebalance)
Eureka!Wejustturnedourlosingscanintoamoney-maker!Okay,a3.7%gain
over5yearsofastrongbullmarketisnothingtogetexcitedabout.Butitshows
usthatweareontherighttrack.Byrequiringthatourpassingcompaniesshow
strongsalesgrowthrelativetotheirshareprice,wehavesuccessfullyweeded
out,onaverage,allthelosingmomentumstocks.
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Now,ifourscanisarobustone,weshouldseeevenmoreimprovementwhenwe
movefroma4-weekrebalanceperiodtoa2-weekperiod.Andthisisexactlywhat
wesee:
5yeartestofPrice+P/SMomentumScreen(Longs,4wkrebalance)
Notonlyhaveourreturnsimprovedfroma-70%losstoa62.6%gain(bothwith
weeklyrebalancing),butwehavealsoreducedthemaxdrawdownforthescanto
amoremanageable-44%!ThisscanstillunderperformscomparedtotheS&P
500,sowehavesomeworktodoyet,butitisahugestepintherightdirection.
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AddingaFundamentalGrowthMetric,PartI
Wecanimproveourscanevenfurtherbyaddingafundamentalfilterthataimsat
averyparticularformofmomentum:anticipatedearningsgrowthoverthenext
quarterthatisstrongerthanwhathadbeenexpectedfromthecompany.Wecan
thanktheaforementionedDr.LenZacksforthisgemofanaddition.Hewrotehis
PhD.ThesisonMITonthetopic.ItwasDr.Zacks’amazingdiscovery,toourgreat
gain,thatthemostpowerfulpredictoroffuturepricegainisthe“earnings
estimaterevision”.Specifically,wheneverananalystorthecompanyitselfcomes
outandsays,“hey,wegotitwrong.Lookslikeourearningsarebetterthanwe
thought…sowearegoingtoreviseourestimatesbyraisingthem.”
Sowhatweneedtodoinordertoaddthismostreliableoffundamentalgrowth
metricstoourmomentumscanistoscanforcompaniesthathave,inrecent
weeks,raisedtheirearningsguidanceforthenextquarter.Itturnsoutthatthisis
moreeasilysaidthandone.It’snotlikethereisasitewhereallearnings
estimatesrevisionsareputonpublicdisplay.Buttherearewaysofaddingthis
filtertoourmomentumscansothatthescanitselfweedsoutonlythosestocks
thathavemadesucharevisionintherecentpast.
Let’slookatthisingreaterdetail.Mostcompaniesissueforward-looking
guidanceforthenextquarterandfiscalyearwhentheymakepublictheresultsof
thepreviousquarter’searnings.Somelargercompanies,andcompaniesin
certainindustrieslikeretail,alsogivemid-quarterupdates.Whencompanies
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maketheseforward-lookingprojections,theyusuallygivearangeofpossibleEPS
valuestheyanticipatefallingwithinbythetimethenextquarter’sannouncement
ismade.Bycomparisontowhatthecompanysaidatthepreviousupdate,this
rangecanbemeasuredaseitherabove,beloworin-linewithprevious
statements.Normally,projectionsmadeabovethepreviousrangearewell
receivedbythemarketoverthenear-term,hencetheirpredictivepower.
Whatwearelookingforinthisfilterisatleasta5%increase–theminimum
amountneededtomaketherevisionmateriallyrelevant–intheprojectedrange
ofQ/QEPS.AsDr.Zacksdemonstrated,thisrevisionisincrediblypredictiveof
near-termfuturepricemovement.I’vewrittenatlengthaboutthisparticular
metricinChapter8ofMarket-NeutralTrading.I’vebuiltseveraltradingsystems
aroundthisfilterandwhencoupledwithsoundtechnicalanalysis,itworks
incrediblywell.Withthisfilteradded,ourmomentumsystemscannowlookslike
this:
• Price>$10pershare
• AverageVolume>100,000
• PricetoSalesRatio<1.0
• Q(1)/Q(0)EPSEstimateRevisioninpast4wks>5%
• 24-week%PriceIncrease=Top#30stocks
• 12-week%PriceIncrease=Top#10stocks
• 4-week%PriceIncrease=Top#3stocks
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Thefollowingchartshowswhathappenstoourreturnswiththisfundamental
filteradded:
5yeartestofPrice+P/S+EPS5%Revision(Longs,4wkrebalance)
Herewiththesimpleadditionofonelinetoourscan,we’veaddedalmost50%of
returnoninvestmentoverthe5yearlook-backperiod.Notonlythat,butwe’ve
alsocutourmaxdrawdownto-37.7%,asignificantimprovement.Still,our
momentumisnotwherewewouldwantittobe.It’simproving,butwearestill
laggingtheS&P500.Thereismoreworktobedone.
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35
Butwait,itgetsevenbetter.Ifa5%EPSrevisioncouldmakesuchan
improvement,whatwoulda10%EPSrevisionfilterdotothereturns?Think
aboutthatforamoment.Toreviseacompany’squarterlyearningsup10%from
previousestimatesissayingalot.It’seithersayingthat“ourformeraccounting
figureswerewayoffbecausewearestupid!”…ormorelikelyit’ssayingthat,“we
arehavinganincrediblequarter,muchbetterthanexpected,withourproduct
flyingofftheshelves,andouroverheadcostslowerthanweprojected,andwith
allthosenewcontractswedidn’tseecomingourway.”
Inanycase,a10%jumpinabullishdirectionissignificant,butwillitchangeour
tradingoutcome?Let’sputthatintoourscanandsee:
5yeartestofPrice+P/S+EPS10%Revision(Longs,4wkrebalance)
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Okay,nowwearetalking!Withourvaluationfilteronboard(P/S<1.0)marking
relativestrengthinsales,andwithourEPSgrowthmomentumfilterrequiringour
passingcompaniestobesurprisingthemarketstotheupsideatleast10%with
theirearningspotential,andallofthattakingplacebeforeweevenbegintolook
atpricemomentum,wenowhaveamomentumscanthatoutperformstheS&P
500.Yeah!That’sthegoalofanytradingsystem,toproduce“alpha.”The318%
5-yearreturnisnearlytwicethereturnoftheS&P.That’salotofalpharight
there.Anditgetsbetter,forwehavealsoreducedourmaxdrawdownto-33.8%.
Butwecanstilldobetter.Watchnowwhathappenswhenwerequirethatour
undervaluedcompaniesraisingearningsestimatesarealsoshowingsignificant
growthinearningsoverthepastquarter.Thisiswherethingsgetreallyexciting!
AddingaFundamentalGrowthMetric,PartII
Wehavemeasuredsalesstrengthrelativetoprice.Wehavemeasuredsignificant
improvementinforwardanticipatedearningsgrowth.Whatweneedtoaddnow
–andthisisourfinaladd–istherequirementthatcompaniesdemonstrateactual
EPSgrowthoverthepastquarter.Itisthemostrecentquarterthatwilldrive
sharepriceoverthenearterm.Wealreadyhaveinplacetherequirementthat
companiescreatetheanticipationofagreatquartergoingforward.Nowwe
needtobolsterthatanticipationwiththeprovenabilityofthecompanyto
producerealEPSgrowth.Remember,manyofthecompaniesthatmakeit
throughourscandonothaveactualearnings.Butgrowthdoesn’tneedactual
HOT STOCKS: Why Some Stocks FLY and Others DIE
37
earningstobemeasured.Areductioninearningslossalsocountsasgrowth.So
thisiswhywecanmeasureEPS(earningspershare)growthincompanieswithno
netearnings.AreducedlosscanalsobeaformofEPSgrowth.
Whatwearelookingforherewiththisfilterisa%changeinactualEPS(actual
EPSmeaningEPSfromthepastratherthanafutureprojection)onaquarterto
quarterbasisgreaterthan5%.Wecanraisethatnumber,butdoingsotypically
reducesourpoolofpossiblecompaniestotoofew,sowewillkeepitat5%.With
thislastfilterinplace,ourmomentumsystemscannowlookslikethis:
• Price>$10pershare
• AverageVolume>100,000
• PricetoSalesRatio<1.0
• %ChangeQ/QEPSEstimate>10%
• %ChangeActualEPSQ/Q>5%
• 24-week%PriceIncrease=Top#30stocks
• 12-week%PriceIncrease=Top#10stocks
• 4-week%PriceIncrease=Top#3stocks
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Usingthesame5-yearlook-backperiodanda4-weekrebalanceperiod,our
returnsnowlookverystrong:
5yeartestofPrice+P/S+EPSRevision+EPSActual(Longs,4wkrebalance)
Fromthischartweseethatourreturnsnowhavepropelledupto540%,afull
3.25timesthatoftheS&P500,anda+220%improvementoverourprevious
scan.Moreover,ourmaxdrawdownisnowdowntoamuchmorereasonable
risk-level(consideringthepotentialreward)of-29.6%.Andwewouldseethose
returnsincreaseagainbydrillingdowntoaweeklyrebalanceperiod.
HOT STOCKS: Why Some Stocks FLY and Others DIE
39
Asgoodasthisreturnis,itisnowherenearthe+30,000%returnIwasableto
attainwithmymomentumscanoverthesame5-yearlook-backperiod.Thisis
the“secretsauce”thatliesbehindthesuccessofTHEHOTSTOXXLETTER
(www.drstoxxtrading.com)anditisaformulaIteachinmyworkwithprivate
coachingclients.Ican’tthereforegiveitawayhere.Butinthescanwehavebuilt
inthismanual,youhavealltheprinciplesyouneedtobeginbuildinghugely
profitablemomentumstockscansonyourown.
Rememberthetwocrucialkeystoprofitingfromtradingmomentumstocksareas
follows:
1. Tradingmomentumstocksbasedonpricemomentumalonelosesmoney!
2. Tradingmomentumstocksprofitablyoverthelong-termrequiresfinding
momentumstocksthatalsohavestrongunderlyingvalueinthesalesand
earningsofthecompany.
Clearlythereisagreatdealofroomforimprovementonthescanwehavebuilt
here.Butitisagreatbasetoworkfrom.Thatisthefunofsystemsbuilding:you
changethisalittlehere,movethataroundthere,andseewhathappenstothe
returns.It’skindoflikefishing:youthrowoutthebaityouthinkwillworkbest,in
thespotyouthinkthefishare,butyouneverreallyknowwhatyouaregoing
catch(ifanythingatall!).
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AFewWordsaboutPositionManagement
BeforeweturntothelastpartoftheManual,Ishouldaddthatnosystemscanis
everasgoodasthepositionmanagementmethodsyouuseonceyouareinthe
trade.Thosewhotradeanymomentumsystemneedtobeawareoftherisks
involved.Thereisnohigh-rewardtradingsystemthatdoesnottakeonoutsized
risk.Itishowthegameisplayed.Sometraderswillwanttousestop-lossesto
managetheirrisk.Myresearchshowsthatstop-losseswillreduceyourmax
drawdown,buttheyalsoreduceyouroverallperformance.Ifyoucanstomach
therisk,thebestrewardwillcomewithholdingontoallpositionsuntilthenext
rebalanceperiod,nomatterwhathappens.
Forthisreason,itisbesttobegintradingyourmomentumscantradesusinga
verysmallamountofmoney.Youareonlybuying3stocksperweek,soitis
perfectlyreasonabletobeginwithaslittleas$3,000,with$1,000goingintoeach
ofyourinitialpositions.Thisway,evena50%drawdown(-$1,500)isnotlikelyto
bringyoutobankruptcy,andifitdidyoushouldnotbetrading.
Thebestwaytofigureouthowmuchyoushouldstartwithistoaskyourself,how
muchmoneycanIaffordtolosewithoutinanywayinterferingwithmyabilityto
paybills,paymydebts,givegenerously,supportmyfamily,etc.Thendoublethat
amountandthatisyourstartingpoint.Thisgivesyoua50%cutoffpoint.Ifat
anytimeyouaredown50%,youstoptradingandclosetheaccount,andyouwait
untilyouarebettersuitedfinancially.Withthistradingsystem,a50%drawdown
HOT STOCKS: Why Some Stocks FLY and Others DIE
41
isnotlikely(its17-yearaveragemaximumdrawdownisonly-27%),butitcanhit
thatandmoreduringamarketcrash.Soitisprudenttokeepthat50%cutoff
numberinmindasyoubegintrading.Knowthepointatwhichyouwillcallit
quitsifthingsgosouth.
InnearlyeverybacktestIranintheResearchWizard,thebestreturnswere
gainedbysimplylettingthesystemitselftakeyououtofthetrade.Withthis
method,ateachrebalanceperiod–whether4weeks,2weeks,or1week–you
simplyholdthestocksthatcontinuetoshowupinthelistofpassingcandidates,
andyousellthosethatdon’t.Thosethataresoldarereplacedwithnewstocks
onthelist.This“rebalancing”canbedonepriortotheopenonMondaymorning
byusing“OPG”or“marketonopen”orderstobuyandsell.
Lettingthesystemitselfstopyououtofatrademakesallkindsofsense.These
days,highfrequencytradersandmarketmakerscanpushstockpricesaround
quiteeasilybysimplypumpingupthevolumeoveraperiodofmarket
inefficiency.Inthiswaytheycanrunthepricethroughyourstop-loss,then
havingtakenawayyoursharesatalowprice,ramthestockpricebackupagain
beforesellingyoursharestosomeoneelseatahigherprice.Thisiswhyweare
seeinganincreaseinintradaypricemovementsanddaytodayvolumelevels.
Toavoidthismischief,wecanletthesystemtelluswhentoexitourtrades
insteadofastoploss.Withourmomentumsystemasoutlinedabove,whena
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42
stockfallsoffthelistittypicallymeansthateitherthestockhasralliedabove
reasonablevaluationlevels,orithasnotkeptupinpricemomentumandthushas
droppedoutofthetop3stocks.Ineithercase,itmakessensetosellthatstock
andreplaceitwithabetterone,namely,onefromthetop3listasdeterminedby
thesystemscan.Yes,tradingthiswaywillmeanthatyouwillneedtotakethe
inevitablelargeloss,whenastop-losswouldhavesavedyoufromthat.Butover
time,youwillseefarmoretradesturnouttobeprofitableattheexitwhenyour
stop-losswouldhavebumpedyououtofthesharesforaloss.
Theotherthingtomentionregardingpositionmanagementisthesystematic
compoundingofyourgainsovertime.Isuggestthatateachnewrebalance,
wheneverthereisanewtradetoputon,youcalculatewhatyourcurrent
portfolioamountis,includingbothprofitsandlossesfromclosedtradesandfrom
openpositions.Thisiscalledyour“mark-to-mark”amount,anditshouldbeused
todetermineyourpositionsizeateachnewrebalanceperiod.Simplytakethat
amount,divideby3,andinvestexactlythatamountintoanynewtrade(s).Inthis
wayyouwillbeincreasingyoursizeduringbullishrunsinthesystem,and
decreasingyoursizeduringdrawdowns.
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PARTFIVE:RULESFORSCANBUILDING
Okay,I’vegivenyoujustabouteverythingyouneedtoknowtobeginbuildingaset
ofrobustmomentumscans.Isuggestthatyoustartwiththefinalversionofthe
scanwebuiltabove.Ihavenoproblemwithyourpiggy-backingonmywork;but
youarebestservedinthelong-runbybuildingandtradingyourownsystemscans.
Someofyoumaybeabletoworkwithsoftwarethatcanautomatethetweaking
process. I’m not that fortunate (nor that technically astute). I do it the old-
fashionedway:linebyline,tweakbytweak,testbytest.Forthatreasonittook
me5yearstobuildthescanwhose+30,000%returnsover5yearsyousawearlier
inthisManual.Hopefully,withthisguideinhand,itwon’ttakeyouquiteaslong!
ThefirstthingIneedtomentionhere isthatthetestingandscan-buildingwork
represented in thisManualwas all done in theResearchWizard available from
ZacksResearch. Youcanreplicatethesesameparameters inStockInvestorPro,
butasIsaidbefore,youwon’tbeabletobacktestyourscans.Thebestyoucando
isrunthescanonhistoricaldataandseehowthosestocksfaredovertime(atrue
laboroflove).Youwillalsoneedtofudgeabitwiththethree“Top#X”functions
inourscan.StockInvestorProonlyallowsyoutoscreenforstocksinthe“TopX
%”ofallstocks.
IfyouuseFinviz,youwillneedtoimprovise.ThereisnofunctionforEPSestimate
revisionsinFinviz,andasforrankingstocksbasedon4week,12weekand24week
performance,youwillhavetodothatmanuallyfromthelistsofstocksthatshow
HOT STOCKS: Why Some Stocks FLY and Others DIE
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upafterfilteringforthefundamentalparameters.Therearetwoperformancetabs
inFinviz, andyoucan screen for the strong stocksusing those (alongwithyour
valuationandgrowthfilters).Onceyouhaveyourlistofstocks,youcanrankthe
stockson thebasisofperformanceoverhalf year,quarterly,monthlyandeven
weeklytimeperiods.Inthiswayyoucangetprettyclosetothesamelistofstocks
thateitherResearchWizardorStockInvestorProturnout.Butthemaindrawback
toFinvizistheinabilitytoscanforearningsestimaterevisions.Youcan,however,
checkthenewsheadlinesunderneaththestocksthatturnuponyourscansand
lookforanyreportofsuchrevisions.Itistedious,butcertainlydoable.
Withthatsaid,inthisfinalsectionletmelayoutsomebasicrulesforbuildingyour
ownmomentumscans.Someofthishasalreadybeentouchedon,butitallbears
repeatinghere.
1. Always startyour scanswithaprice filter (I suggestkeep to stocksabove
$10/share).
2. When building your scan(s), set the fundamental filters before the price
momentumfilters.
3. Trybothloweringandraisingtheaveragevolumefigureifyougettoofewor
toomanystockspassingthroughthescan.
4. ThePrice/Salesvaluationfiltershouldneverbegreaterthan1.0asamax.
Tryexperimentingwithlowervaluestoseeifyoucanimprovereturns.All
studiespointtothatnumberasastrongdividing linebetweenstrongand
weakperformanceovertime.
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5. TheEPSQ/QEstimateRevisions filter canbeplayedwith. Try raising the
valueabove10%.TryaddingFY/FYalongwithQ/Q,oreveninsteadofQ/Q.
6. The%changeinActualEPSQ/Qcanalsobeplayedwith.Tryraisingthevalue
above5%.TryaddingFY/FYalongwithQ/Q,oreveninsteadofQ/Q.
7. Forthe3linesofrelativepricestrength–short-term,mid-term,long-term–
try changing the “Top #” values. Lower numbers will generally improve
returnsbutalsoincreaserisk.
8. Firstmakesureyourscanissignificantlyprofitableusinga4-weekrebalance
period.Thenloweritto2-week,then1-week.Themostrobustscansshould
improveateachchange.
9. Besuretorunyourbacktestsoverdifferentmarketperiods.You’llwantto
makesureyourscanoutperformsinabearmarket(e.g.,2000–2002and
2007–2009)andinarelativelyweakbullmarket(e.g.,2003–2006).
10. Be aware that the Research Wizard backtesting feature counts Friday’s
closingpriceastheofficialentry/exitprice,butnewdataisnotavailableuntil
Mondaymorning.Thustheretendstobealagbetweenbacktestedresults
andreal-timetrading.Sometimesthisworksinourfavor(ifstocksgapdown
Mondaymorninggivingusabetterentrythanthebacktestedresults),but
sometimesitdoesnot.
11. Ifyoupreferamoremarket-neutralapproach,youcanbuildashorts-only
scanasacompanionsystemtoourlongs-onlymomentumsystem.Myown
testingovertheyearsshowsthatashorts-onlymomentumsystemcanbe
profitablebutalsoveryvolatile,sobeawareofthatandpositionyourself
accordingly. To build a shorts system, try reversing the fundamental
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46
parametersbutkeepingthepricemomentumfiltersinbullishmode.So,for
example,youcanstartwiththefollowingscan:
• Price>$10pershare
• AverageVolume>100,000
• PricetoSalesRatio>1.0
• %ChangeQ/QEPSEstimate<0%
• %ChangeActualEPSQ/Q<0%
• 24-week%PriceIncrease=Top#30stocks
• 12-week%PriceIncrease=Top#10stocks
• 4-week%PriceIncrease=Top#3stocks
Thethesishereistoshort“junk”stocksthatareinrallymodeinthe
anticipationthatrealitywillkickinandtheywillfallbacktoamore
appropriatevaluation.Remember,justusingtheveryfirstscanwebuilt
aboveisalreadyaprettygoodscanforfindingshortsetups.Ifyouadd
filtersthatscanforlousyfundamentalstoo,you’vegot,intheory,an
awesomeshortingsystem.Youwillneedtoplayaroundwiththeprice
performancenumbersabittogetarobustscanoverdifferentlook-back
periods.Butitispossibletogetashorts-onlymomentumscantestedover
thelast5yearbullmarketthatshowsstrongtriple-digitgains,anddouble-
digitannualreturns.Andoverbearmarketperiods,thereisnothingmore
profitablethanshorting“junk-momo”stocks.Keepinmind,however,that
inmyexperience,shortingmomentumstockscanbeaveryrockyridesoit
isalwaysbesttogoinwithverysmallpositionsizes.
HOT STOCKS: Why Some Stocks FLY and Others DIE
47
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