Stock picking on steroids
Everything we do in TradeStops is about helping investors find investments that can be held for years and generate outsized returns with limited risk.
For the past several weeks, we’ve been looking at how “going green” by using the TradeStops SSI system, does just that. This week I’ve got a powerful new idea to share with you that potentially puts this strategy on steroids.
I do feel a mild cautionary note is in order: this article will be a bit of a tease because what I’m going to share with you is not something that you will be able to easily replicate on your own.
As you know, our TradeStops Volatility Quotient (VQ) is a proprietary indicator that gives investors an easy to understand way to gauge how much a stock is likely to move up or down, over the course of a year or more, just due to volatility or “noise” in the stock.
What you may not yet know is that we update this VQ value on every stock in our database every week. Just like stock prices move up and down, VQ values move up and down as well … and we have that data.
By studying how our VQ indicator rises and falls over time, I believe that we can further juice our SSI system by finding the investments that have built up the highest potential of starting a multi-year run once an SSI Entry signal is triggered.
The key is to look for those opportunities that have built up a good amount of volatility-energy prior to triggering a new SSI entry signal. The S&P 500 provides a great example.
Here is a 40-year chart of the S&P 500. The current VQ on the S&P 500 is 10.9%. You can see in the chart below, however that this isn’t what the VQ on the S&P 500 has always been. In early 2009, for example, it reached a peak of nearly 25%.
The key to identifying investments that are primed for multi-year uptrends is to find those investments where VQ has risen substantially (often as much as 100%) and is poised to start declining as a new uptrend takes hold. This built up “VQ-energy” is like fuel that has been stored up. The SSI entry signal is the fuse that lights the fire.
Each peak in VQ in the chart above corresponded with a bottom in price for the S&P 500 … and the start of a multi-year uptrend.
Even though I said this “is not something that you will be able to easily replicate on your own”, that’s not entirely true. With the recent enhancements to the Stock Analyzer, it’s easy to see the historical changes in the Volatility Quotient. Here is how the 10-year chart of the VQ% for the S&P 500 is shown in the Stock Analyzer. It is highlighted in the red box.
Another great example of this is Northrop Grumman Corp (NOC). The chart below shows how even in an individual stock, these peaks in VQ can be powerful indicators of significantly higher prices to come.
From 2007 to 2009, the VQ on NOC rose from below 12% to nearly 25% – a gain of over 100%. In October of 2009, VOC triggered a new SSI entry signal at about $38 per share. Today NOC is worth $250 per share – a gain of over 500%.
That’s the kind of gain all of us need to experience at least a few times in our investment lives.
I’ve shown you the long upward climb of Constellation Brands (STZ) several times. What I hadn’t noticed before is how the volatility of STZ peaked after the financial crisis of 2007-2009.
The VQ for STZ in early 2010 was close to 30%. Today, it is 16% … and investors who got in at the original SSI Entry signal more than 3 years ago have been riding the wave higher as the built up VQ-energy has been spent.
Most investors are afraid of volatility. Not me. I relish it.
I relish it because I know that when it comes to understanding and leveraging volatility, I have an edge. I know that there is no sure thing when it comes to investing. I don’t add a false sense of certainty to my thinking. I recognize the fundamental uncertainty of investing and I make the most of it.
Stay tuned to hear more about this new research in the coming weeks and months,
Richard M. Smith, PhD
CEO & Founder, TradeStops
Making Money with “Only” 53% Winning Trades
Over the past month, we have been showing TradeStops members the importance of investing in stocks that have strong up-trending momentum. The basis for all of this research goes back to an article that was published over the summer.
This past August, Dr. Smith wrote an editorial that shows the power of the Stock State Indicator Entry signals and Stop signals. In 37% Per Trade over 20 Years, he presented the following statistics that sum up 20 years of backtesting using 1300 different tickers. These tickers include stocks, indices, funds, and commodities. And the results are incredible.
The study had almost 7500 trades. And 52.7% of these were winning trades. Of course, that means that 47.3% were losing trades. The average winning trade was +84.3%, and the average losing trade was -16.4%. This means that the winning trades outperformed the losing trades by 5-1.
Some of our TradeStops members expressed concern that the winning trades were only slightly more than 50%. They wanted to know why this is a good number.
It’s difficult to blame their thinking. After all, we routinely see ads promoting 75% winners, 80% winners, and even some who advertise that they have 90%+ winning trades. 53% winning trades pales in comparison to these others.
But the purpose of investing is not just to have winning trades. The purpose of investing is to make money. Period. Let’s look at a simple example that shows the power of 53% winning trades.
In this example, we’re going to have one stock that makes money and one stock that loses money. This portfolio, with a 50% win rate, has a worse win rate than the 53% win rate that TradeStops achieved.
We’re going to use two fictional stocks, ABCD and WXYZ, that each have the same Volatility Quotient of 20%. We’re going to invest $100 in each stock. ABCD will have a gain of 5 VQ% and WXYZ will have a loss of 1 VQ%. This is the same win/loss ratio that we saw in the 20 years of backtesting.
Here are the results of the two trades.
The results are powerful.
These two trades, one a winning trade and one a losing trade, generated a profit of $80 or 40% of the total amount invested. It’s as if you would have made 40% profit on each trade.
Let’s look at these results from the perspective of the “smart money” investors. Institutions and hedge funds look at the TradeStops methodology as a “black box” system. This means that the SSI Entry signals and the SSI Stop signals are generated by a computer. There is no human intervention into the signals because everything is based on the series of algorithms developed by Dr. Smith and his team.
This black box system makes managing your investments much easier. There is no guessing as to when you should buy or when you should sell. And it’s this type of black box technology that is taking over the investing world. You’re the beneficiary of the fact that TradeStops is on the leading edge of developing this technology.
That doesn’t mean that there is nothing for you to do. It’s still up to you to determine how much risk you’re willing to take. It’s up to you to determine the percentage of investments in stocks and bonds. And it’s up to you to make the decisions on which stocks to buy and sell in your portfolios.
Hopefully you now have a better understanding of why 53% winning trades is so important for your investment portfolios. It’s not the percentage of winning trades that makes a difference, it’s how much you can make on your winning trades in comparison to your losing trades.
Hurricane warnings in November?
Last month I wrote to you about the potential sea-change brewing in long-term interest rates. At the time I wrote, “Is this sea-change upon us today? Not yet … but the winds of change are stirring.”
Those winds of change have reached tropical storm levels in the past couple of weeks and are threatening to turn into an outright hurricane.
The key chart to keep a close eye on is this one – the chart of long-term Treasury Note yields, dating back to the Reagan presidency.
The trend lower in long-term interest rates is the trend to beat all trends. It’s been 30 years in the making … and the trend line is currently under attack as can be seen in the bottom right of the chart above.
I wouldn’t say that this trend is broken just yet. We’ve seen brief breaches of this trend before – most notably in 2007 – 2008. What we’re seeing today, however, is very serious.
The whole structure of modern finance today is built on an assumption of persistent low long-term interest rates. If long-term rates in the US rise dramatically, they will be the undoing of many a financial engineer.
In the past 5 months alone, yields on Treasury notes are up nearly a full percentage point from just under 1.4% to nearly 2.4%. That’s an increase of nearly 70%!
The damage already done to interest-rate sensitive instruments like utilities and REITs has been swift … and brutal.
Utilities have dropped almost 11% from their highs less than 5 months ago.
REITs are even worse. They’re now down an incredible 23% in less than 5 months.
Popular bond funds like the iShares 7 – 10 Year Treasury Bond fund (IEF) have blown through their SSI stop losses.
Existing income investors in such funds are in a tough spot because they locked in lower long-term yields and have seen their capital take a serious hit as long-term yields moved higher.
On the other hand, investors who have been waiting for a good opportunity to add some income generating investments to their portfolios may be in luck. Current yields are much higher than what they were even a few weeks ago.
Is this a good time to lock in some higher yields while we can? It’s an interesting question … and it depends, of course, on your time horizon.
My latest cycles analysis on Treasury Notes suggests that we’re likely to see a short-term bounce in T-Notes soon (which would mean lower yields) but then a further decline into the spring of 2017.
I’m personally not ready to start reaching for yield just yet … but I am closely monitoring the situation.
I’d say that we live in interest-ing times!
Richard M. Smith, PhD
CEO & Founder, TradeStops
What do you mean 2 VQ?
Last week’s article on doubling up on your winners seems to have struck a chord. After reading it, longtime subscriber Joe M wrote in and said,
Just so you know, as I was reading this, I said out loud, “YES!!” That reaction rarely happens….
Joe wasn’t the only one that had something to say about our recent research. Phillip D. wrote in asking for some clarification.
Been reading Richard Smith’s recent articles with interest. One concern I have is that we are told to buy more of a rising stock that has an SSI entry signal after it has reached 2 VQ’s (and then more after another 2 VQ’s etc.). But we are also told that it’s OK to buy the stock at a price of up to 2 VQ’s following the SSI entry signal, which implies it’s not OK to buy above the 2 VQ level. Am I missing something?
Phillip is referring to a point of possible confusion from the past two Tuesday editorials that we’ve published. Let me explain.
In the article mentioned above on “doubling up on your winners,” we presented a strategy for adding to winning positions after every 2 VQs of gain. We shared an example of this strategy using Constellation Brands (STZ) and adding to this winning position at each of the blue arrows on the chart below.
The week before last, however, we had written to readers on the topic of “when is it too late to buy after an SSI Entry signal?” In that article we used the example of Berkshire Hathaway and shared that our research showed that it would have been a good bet to buy Berkshire any time before it gained more than 2 VQs from its initial SSI Entry signal.
As Phillip points out, in one article we’re saying, “Don’t buy if the stock has already gained more than 2 VQs,” and in the next article, we’re saying, “Buy more every time the stock gains another 2 VQs.”
The confusion is understandable.
First, let me say that I do want everyone to understand that the research we’ve been sharing these past few weeks is still evolving. We’re very excited about it … and it has impacted my personal investing strategies already … but there is still more research to be done before we bake this into the cake as an official TradeStops best practice.
That said, there is an explanation for the apparent contradiction that Phillip has flagged. In the example of Berkshire Hathaway, we are only referring to the initial position in the stock. If a stock triggers an SSI Entry signal, our research shows that it’s best to establish an initial position before the stock has gained 2 VQs. (In the case of Berkshire, the VQ was 12% so that means buy before it has gained 24% from its entry signal.)
If, however, you have established an initial position within 2 VQs of the initial entry signal, our research further suggests that if you add to the winning position after each successive 2 VQs of gains, you have a great chance of making more money than you would if you don’t add to such winning positions.
Let’s look at how this might work using our example of Berkshire Hathaway again.
Berkshire first triggered an SSI entry signal in mid-2012 at around $85. At the time it had a VQ of 12%. According to our first research piece, it would have been safe to buy Berkshire up to $105.40 (24% above $85).
An investor could have purchased Berkshire 6 months later in early 2013 at $97 and still been confident of profits. Should our investor have decided to follow the suggestions of our “doubling up” research, then s/he would be looking to add to this winner after another 24% gain from the $97 entry price … at about $120.
I hope that clears up any confusion, Phillip.
Subscriber Joe M., who I mentioned at the top of this article, referred to this “add to winners” strategy as “watering the flowers.” I love that idea. Our trailing stop strategies help us to pull the weeds from our portfolio, and this strategy of adding to winners is like watering the flowers that remain.
Great metaphor, Joe!
I hope that everyone enjoys a rest-filled holiday. We all deserve it after surviving the markets of 2016.
To watering the flowers,
Richard M. Smith, PhD
CEO & Founder, TradeStops
The New Stock Analyzer
Last week, we brought to you the new TradeStops Stock Analyzer. This takes the place of the Stop Loss Analyzer under the “Research” tab and is now the first place you should go to get an overview of stocks that you own or stocks that you’re considering adding to your portfolio.
If you own a stock, you’ll want to enter your purchase date into the “Entry Date” window. If you’re researching a stock, you can leave today’s date as the default. For this example, let’s look at Microsoft (MSFT).
The Stock Analyzer has three main sections. The two sections at the top of the page examine the stocks or funds with different stop loss settings, and the bottom section shows the chart of the stock or fund based on the inputs that are important to you.
The first section on the left side of the screen shows the stock itself with its current Stock State Indicator status, the Volatility Quotient percentage, the VQ trailing stop based on the Entry Date chosen, the change in price from the previous day, and the historical returns of the stock.
In the case of MSFT, you can see that it has been in the SSI Green Zone for more than four months. The Volatility Quotient is 16.96%, and the VQ Stop price is $50.35.
MSFT closed at $60.64 on Thursday, and you can see the returns for the past one and three years as well as the daily trading volume.
The second section on the right side of the screen lets you see different stop loss settings based on the Stock State Indicators, the Volatility Quotient, or fixed percentage trailing stops.
You can click on the pencil icon and change the Trailing Stop percentage. You can also go back and change the Entry Date to see the difference that makes in the different Stop Prices.
The third section at the bottom of the page is the TradeStops chart with numerous settings you can choose to show or not show. This is what it looks like with all of the settings checked. (Click image to expand.)
And here’s what the chart looks like with all of the settings unchecked. (Click image to expand.)
Let’s take a look at the different chart settings and how they can be used to help you analyze the stocks you own or are considering owning.
Having all of these checked could create some confusion when looking at the chart. Let’s assume that we want to use the SSI Stop as our exit strategy. We can then uncheck the VQ Trailing Stop and the % Trailing Stop. Also, the stock’s volume and historical VQ% are not as important to me when I’m looking at the chart, so let’s uncheck those as well. This results in a cleaner, easier-to-understand chart. (Click image to expand.)
We recommend that you play around with the settings so that you can personalize the chart to show only those items that are of importance to you.
And we have more changes that will take place over the next few weeks that will make the Stock Analyzer even easier to read.
Enjoy the latest TradeStops upgrade!
The signal I’m waiting for in gold
I’ve got good news for long-term gold bulls. There’s reason to be optimistic. Shorter-term, however, concerns remain.
Part of my market preparations for each year include taking a step back and looking at the big picture across various financial markets. To see the big picture, I look at two things – long-term cycles and what the smart money is doing.
I know that there are all kinds of reasonable explanations of why markets move this way or that. Over the years, however, I’ve heard scores of intelligent people logically explain why something should happen only to then see its exact opposite take place.
As Keynes said, “Markets can remain irrational longer than you can remain solvent.”
So I look to my two indicators – time cycles and smart-money sentiment.
The long-term chart below shows the most prominent cycle in gold that I’m aware of – the 8-year cycle. It also shows how the smart money (the commercial participants in the futures markets) have been consistently bullish at bottoms and bearish at tops.
The 8-year cycle in gold is bullish right now and will remain so through 2020. Smart-money sentiment was very bullish earlier this year but is currently bearish.
When longer-term indicators are in conflict, it’s helpful to drill down to shorter time frames to get more insight about what’s going on.
The current SSI chart on gold is still moderately bullish. The SSI Trend is still up but gold is very close to crossing its SSI Stop Loss line. As I write at this moment, gold is down again today and is in danger of closing below $1,209, which would trigger the stop. I expect that will likely happen.
Let’s take a look at the shorter-term cycles and smart-money sentiment.
Here again we can see how commercial hedgers, aka the smart-money, are regularly and correctly bullish when gold is bottoming. They are not bullish right now … which strongly suggests that gold has likely not found a bottom yet.
My best guess is that we’re likely to continue to see weaker gold (and gold miners) into the end of 2016. I’ll be looking to see when the smart-money gets bullish before I get bullish again too,
Richard M. Smith, PhD
CEO & Founder, TradeStops
Doubling up … on your winners
Doubling down on losing positions is a common strategy amongst average investors. The thinking is usually that buying more shares at a lower price will help get the position back to “break-even” faster.
Thinking about “doubling down” got me wondering … is there ever a good time to double up on a winner?
Developing a smart strategy for helping TradeStops subscribers add to their winning positions is a topic that has been on my mind for years now. Today, I have the beginnings of such a strategy to share with you.
The question I put to my research team was, “When is a good time to add to a winning position?” The answer we’ve come up with is, “After 2 VQs.”
I’ll start by illustrating with an example.
Constellation Brands (STZ) is a stock that could be the poster child for TradeStops. I’ve written about it many times before. This stock has been in a nearly uninterrupted uptrend now since early 2009 when it traded for about $10 per share. Today STZ sits above $150 per share … and it’s been a smooth ride all the way up.
STZ last triggered an SSI Entry signal back in February of 2013. At the time, STZ was trading for about $43 per share, and the VQ on STZ was 21%. What I mean by “after 2 VQ’s” is that we would look to add to our position in STZ once it had risen about 42% (that’s 2 x 21%) to $61.
The following chart will show you what I mean.
(Note that I’ve used logarithmic scaling for the price axis so that equal vertical distances represent equal percentage gains. From $30 to $45 is a 50% gain. From $45 to $68 is another 50% gain. Etc. It helps make the VQ% moves look more equal.)
Using this approach, we would have added to our original position in STZ when we got a gain of 42% from our original entry. Again, since the VQ on STZ was 21%, a 42% gain is a 2 VQ move. This happened on November 11, 2013 – about 8 months after our original entry.
At the time, STZ was trading for $63.90 per share and now had a VQ of 21.5%.
Following the same logic, we would next consider adding to our position in STZ if and when it rose another 2 VQ’s from our last entry point – i.e., 2 x 21.5% = 43% from $63.90.
I know that’s more math than some of you may feel comfortable with. I appreciate you bearing with me. I feel obligated to spell out all the details for those that want to be able to exactly reproduce what I’m suggesting.
Here’s how the next couple of steps look on our chart.
Are you starting to get the idea?
Here’s a table showing all of the individual trades in STZ using this strategy, including what the new VQ was at the time of each new trade.
Our initial investment at the first entry signal on STZ was $1,000, and we added another $1,000 each time that the position gained another 2 VQs from the previous entry point. Using this approach, an investor in STZ would currently be sitting on a gain of $4,952 vs. a gain of only $2,543 from the original $1,000 investment.
Here are all the entry points on the final chart.
Alright. Now that you, hopefully, understand how this method works, let me briefly share with you why we settled on it.
First off, a gain of 2 VQs is a nice round number … and our brains like nice round numbers. Round numbers make sense to us. We feel more comfortable with them. A stock that is already up 2 VQs has a solid gain. It’s demonstrating strength. We’ve got some profits to play with.
Second, if the stock starts falling right after this initial 2 VQ gain and after adding to our winner, we’ll still end up with a net profit even if we get stopped out without any more gains.
Finally, and most importantly, is that we back-tested this “add to winners after 2 VQs of gain” strategy, and we found that we made about 50% more net profit across all of our trades … and we did so without lowering our win percentage and without taqking on extra risk.
I’m excited about this new research and will be digging into it more in the weeks and months ahead. I’ve long suspected that a strategy for adding to winners would be a very valuable one for individual investors. It looks like we’re onto something,
Richard M. Smith, PhD
CEO & Founder, TradeStops
A Powerful Resource at Your Fingertips
As you already know, TradeStops is the industry’s best site for managing your individual stocks and portfolios. These tools help tens of thousands of investors to invest more intelligently and have a greater opportunity to make more money.
But possibly the best tool within TradeStops is available to every subscriber and it’s even available to non-subscribers.
And that tool is Dr. Richard Smith himself!
Dr. Smith delivers two editorials every week in which he teaches you about the TradeStops tools and how they can help you become a better investor. And he’s always looking for new opportunities and strategies that investors can use to make money in the stock markets.
Accessing his articles is easy, just click on the “Blog” circle at the bottom of the Welcome page.
A new window opens up and the editorials and other educational articles are laid out in reverse chronological order.
But there are dozens of articles. And going through all of them can take a lot of time. So we’re going to make things easier for you. Here are some of the most important articles that Dr. Smith and his team have written. And we have categorized them according to the articles’ focus.
Investment Philosophy and Tools
There were a series of articles in June, 2015 that give a great overview to trailing stops and the evolution of just using fixed percentage trailing stops to stops that are based on the actually volatility of the underlying stocks themselves. Some of the verbiage that is used in these articles is not used today. But the theories are well-explained and they’re a good starting point for understanding the TradeStops underlying philosophies.
Here are those articles:
What it Takes to be a Successful Investor, Part I
Successful Investing Part II
Successful Investing Part III
There is another good article from June, 2015 that discusses volatility-based investing.
Volatility Based Investing
Recently, Dr. Smith has had a series of editorials that highlight the power of the SSI Entry signal and the advantages of buying on strength rather than trying to pick a bottom. These started in October and will continue into November.
The first article discusses the success rate and potential profitability of waiting for a new SSI Entry signal to be generated.
The second article in the series investigates how long winning stocks should be held (and the answer will surprise you).
Capturing Crazy Gains
The next article in the series generated a large amount of member questions and comments. Everyone knows how much they stand to lose in any trade. The question that everyone wants to know is….
How Much Can I Gain?
The latest article examines the success rate of buying into a stock after it has already started moving higher.
When is it too Late to Buy?
Investment Strategies Based on the TradeStops SSI Signals
Dr. Smith has instructed his research team to find quantitative strategies that use the TradeStops SSI Entry and Stop signals to create potentially profitable trades.
The first of these is the simplest. We wanted to know if we could outperform the S&P 500 by using only the ETF that represents the S&P 500 (SPY). The answer is a resounding yes.
How to Crush the S&P 500
The next strategy involves sector rotation. Dr. Smith wanted to see if using just 9 ETFs that represent different sectors could be used to beat the market. Of all the newsletters written in 2016, this one generated the most response and questions from our members.
Triple the S&P 500 with Just 9 ETFs
We created a separate document that explores the 9 Sector ETF strategy in greater detail.
The TradeStops Sector ETF Strategy
Our research team continues to look for other strategies that are fairly simple to execute and have the potential to generate positive returns for our members.
Dr. Smith is very interested in understanding what causes investors to make the decisions that they ultimately make. He has discussed these behaviors in several of the editorials.
A recent article from May looks at different cognitive biases that ruin investors’ results.
Do You Need Financial Therapy?
And in September, Dr. Smith wrote about the fear of regret and how that is the…
The Single Biggest Threat to Our Success
Finally, most every Friday, Dr. Smith shares with you his views on the financial markets. Topics can include stock markets, commodities (gold and oil in particular), bonds, the dollar, etc. He shares the proprietary tools he has developed over the last 20 years to help you differentiate between noise in the markets and what is actually happening.
Sometimes he’ll even unearth a strategy that is rare to find, but has had very successful results. He found an interesting trade on the DJIA using his Seasonal Trader website.
The Most Remarkable Trade of the Year
Feel free to share these editorials with your friends who are also interested in investing. No reason to keep this powerful resource to yourself. And if you have any questions, send an email to email@example.com.
Trump won … Ho hum
Investing, like politics, has a lot more noise than true signal. My investment philosophy is to separate the signal from the noise … and to use to my advantage the fact that I understand “noise” better than most.
That’s what the TradeStops Volatility Quotient (VQ) is all about. It tells me how much noise I need to accept in my different investments.
I have to say that it has performed exceptionally well during this election season – essentially allowing me to ignore all the day to day back and forth and focus on the clear signals.
I’ve been saying for weeks now that, contrary to popular expectations, the stock market was likely to rally to new highs before having a more serious correction. I could say that with confidence because there were numerous signals suggesting higher prices to come AND the “noise” we have been experiencing around the election was well within tolerable levels.
Even on the eve of the election, as it became clearer that Trump had a real chance to win and stock futures started crashing, I could still see that we were within acceptable levels of noise. While everyone was freaking out over this:
I was looking at this:
The sharp drop in the futures markets on the night of the election barely even breached the SSI Yellow Zone. (The SSI Yellow Zone tells us when an asset is getting close to correcting more than it should, but it hasn’t yet stopped out.)
Of course, we had seen this script before … with Brexit. That was also reassuring.
Last week we noted how the S&P 500 was likely to rally after having been down 8 days in a row. Since then the S&P 500 is already nearly 4% higher. I also told you a couple of weeks ago about the strong seasonal influence for stock prices through January.
My time-cycle forecasts continue to suggest that this strength in the market could continue into the end of December.
Now don’t get me wrong. I’m not suggesting that the election of Donald J. Trump as the 45th president of the United States of America is all noise and no signal. There are some serious signals developing, which I’ll be covering in the coming weeks.
But when it comes to the US stock market, the signal for higher prices was there before the election and most of what everyone else was freaking out about turned out to be noise.
As long as everyone else is willing to let themselves get swept up in the noise, I’m confident that there will continue to be opportunities for risk-savvy investors to profit.
I hope you will be one of them,
Richard M. Smith, PhD
CEO & Founder, TradeStops
When is it too late to buy?
We’ve been talking the last few weeks about the power of “going green” … i.e., buying a stock after it has already gone up quite a bit already.
Three weeks ago, I showed everyone the virtue of buying on strength. Two weeks ago, we focused on the importance of sticking with winners. Last week, we looked at a question that every investor wants to know… How Much Can I Gain?.
All of these articles have leaned heavily on the idea of momentum – the fact that stocks that are rising in price often keep rising … and stocks that are falling in price often keep falling.
I had the chance to discuss this important concept in person last week with Alexander Green, the chief investment strategist of the Oxford Club during a webinar that we hosted together for Oxford Club members.
Alex made the point that when it comes to investing … higher prices are often predictive of even higher prices to come because higher prices mean that the stock market is actually anticipating more value creation from the company. It’s a great point.
As you know, momentum is a key component of our Stock State Indicator (SSI) system. A stock changes from red to green in the SSI system only after it has already gone up a healthy amount and has started a solid uptrend.
I’ve asked my team to continue our research in this area because I find it so personally compelling. It’s deeply ingrained in me to try to buy things that have gone down in price … to get a “deal.” Buying a stock that has already gone up a lot has been one of the hardest truths for me to accept as an investor.
So this week I asked my team to look into when it is too late to buy a stock that has already changed from red to green. I think that you’ll find the results very interesting.
Let’s start by revisiting one of the stocks that we looked at last week – the SSI chart on Berkshire Hathaway (BRK.B). Here’s the chart that we looked at last week.
Berkshire triggered an SSI Entry signal (i.e., the SSI changed from red to green) in mid-2012 when the stock was trading for about $85 per share. After triggering the SSI Entry, the stock rose about 60% over the next three years before finally stopping out at $135.
The question I wanted my team to answer was, “When was it too late to buy Berkshire after the initial SSI Entry signal?” The answer was up to 2 VQ’s.
VQ is the magic number in TradeStops. It tells us how much we should expect any stock to fluctuate over the course of a year or more just because of “noise” in the stock. It’s the minimum amount of room that we need to give a stock in order to give it the best chance of making us a lot of money.
The VQ on Berkshire at the time of the initial SSI Entry signal was 12%. After the SSI changed from red to green, Berkshire went on to gain 60% or 5 VQ’s before finally stopping out again at $135.
Our research this week found that it was still a good reward to risk opportunity to buy a stock like Berkshire as long as it had not yet gained more than 2 VQ’s (24% in the case of Berkshire) after triggering an SSI Entry signal.
Here’s what that range looks on the chart of Berkshire.
The other chart that we looked at last week was Nike (NKE). Nike triggered an SSI Entry signal at about $25 back in early 2013. At the time it had a VQ of 16%. Nike went on to gain 126% or nearly 8 VQ’s before stopping out again in late 2015.
The following chart of Nike shows what the “0 to 2 VQ area” looked like for Nike.
Pretty interesting, isn’t it?
Nike had bottomed in October of 2012 below $22. It wasn’t even that volatile of a stock at the time. The VQ was only 16%. Our research strongly suggests that it would have been a solid opportunity to have bought Nike even after it had already risen as high as $33 … or nearly 50% above its $22 low.
I don’t know about you, but buying a conservative stock like Nike that’s already up 50% is not the way I think … or at least, it’s not the way that I used to think.
To buying on strength,
Richard M. Smith, PhD
CEO & Founder, TradeStops