, Educational

Low Risk Runners and Small Cap Stocks

July 30, 2018 / by TradeSmith Education

Over the past several months, we’ve introduced you to new strategies and kept you informed of our current thinking in the stock market.

If you’ve kept up with TradeSmith’s editorials, you know that, given the prevailing economic environment, we prefer domestic small-cap stocks. He wrote about that two months ago.

Last month, we showed you how to find small-cap stocks that also qualified for the Kinetic VQ strategy. Today, we’ll show you how to find small-cap stocks that qualify for the Low Risk Runner strategy.

First, let’s do a quick overview of the Low Risk Runner strategies. The entry signals are the same, but there are two different exit strategies.

A stock qualifies as a “Low Risk Runner” when its Stock State Indicator (SSI) status moves from the SSI Yellow Zone back up into the SSI Green Zone.

Why is this Yellow Zone to Green Zone movement important? A stock in the SSI Yellow Zone has corrected from its high, but it hasn’t hit its SSI Stop signal. It is still within its normal range of volatility. It’s very common for a stock to take a breather, move down into the SSI Yellow Zone for a while, and then regain its upward momentum.

Here’s the chart for Intel (INTC) that illustrates this perfectly. For close to a year, INTC traded in a narrow range, moving into the SSI Yellow Zone on three occasions. It never came close to stopping out, though, and began moving higher again almost a year after first entering the Yellow Zone.

Intel (INTC) illustrates Low Risk Runner by entering SSI Yellow Zone and then beginning upward trend

You can see why we call these “Low Risk Runners.” The normal Volatility Quotient (VQ) on INTC was 17.4%, but by entering the trade when INTC moves from Yellow to Green, and by using the SSI Stop, you’re only taking 9% risk in the trade instead of the normal 17.4% if you were to buy at the high.

This is the first exit strategy with the Low Risk Runners. You use the same SSI Stop signal as you normally would.

The second exit strategy is more aggressive. With this strategy, you hold onto the stock for exactly eight months before selling it. It doesn’t matter if it hits the SSI Stop and enters into the SSI Red Zone.

Here’s an example of the second strategy with Johnson & Johnson (JNJ). The entry into the trade was in November. Eight months later, the exit occurred in July.

Johnson & Johnson (JNJ) illustrating Low Risk Runner, hold for 8 months and exit strategy

Here’s an overview of the results of both strategies. The first exit strategy has a smaller winning percentage, but the gains are larger. The second strategy has a much larger winning percentage, but the gains tend to be smaller.

Comparison of both Low Risk Runner strategies, Buy and Exit by SSI, and Buy and Hold for 8 Months

Let’s look at some small-cap stocks and apply this strategy. We’ll focus on the stocks that are part of the S&P 600 Small Cap Index. They’re part of the SLY ETF.

Of the top 100 holdings of SLY, only five are in the SSI Yellow Zone. Since the trigger for a Low Risk Runner Stock is moving from the Yellow Zone into the Green Zone, we’ve set up SSI alerts for these so we’ll be notified when they are back in the SSI Green Zone.