Spread Betting - Tips For Selecting Stocks That Guarantee High Returns


Q. How do you find the right stocks to trade at the right time?


Share
Can you explain your system of stock selection, what makes you pick a stock to research in the first place?

A: Timing the buys is always difficult. Look at the thousands of stocks offered by spread betting providers and you'll see that this is not a straightforward process. This question could be answered by 20 odd traders as to why they picked a particular share and you'd probably learn a huge amount. You'd see the reasons then the results and could start to develop your own system from this.

In practice, everyone has their own strategy of how/what to trade. Some trade based on news, technical analysis, fundamentals, or a combo. How else can you find the shares? Look at the shares being highlighted on your trading screener; say the Digital Look screener - percentage gainers and losers, breakouts, new issues etc. I trade mostly based on technical analysis. I just pull up a screener (i.e. scanning software) and find stocks with the criteria I want and then trade them. So I may look at some 200 different share charts during a trading day but only spend a few seconds to decide whether a particular one is of interest and whether it deserves closer attention - this is really a skill you develop over time. The Digital Look screener is quite good in this regard with plenty of parameters you can play about with to help you filter stocks and there is even a bit of technical analysis on it. This usually generates me about a 100 or so stocks to review to see if they tick the boxes and whether I think there's upside. It sounds a lot but once you've done it, the only ones you're interested in future are the new ones that come onto the list when you run it a week or so later.

What is scanning software? Scanning software simply looks at the price feeds from the shares you are interested in and then cross-checks the price and volume stats to trace those triggering potential entry and exit signals on price charts. The trader then looks at the charts to see if any shares meet the predetermined entry criteria. These would include a requirement that the share must be liquid enough to buy and sell easily.

Note however that there is no for hard work. The scans simply present us with a set of choices that satisfy our criteria but unless we can afford to buy them all, we then need to do some work to decide which stocks are likely to keep going up (or down).

But before you find the stocks you want you need to develop a strategy. After you know what strategy/system you're using you can apply that to which types of stocks you are interested in.

In practice monitoring shares is a perpetual problem - alarms and indicators are helpful, but unless you constantly monitor your monitor (!) you can miss entry / exit points. I think most people will miss opportunities because you can't cover everything all the time. Some people's minds are more suited to remembering prices and positions and will notice a difference when viewing a list of stocks.

I find it's all very well monitoring stuff you've already bought, but as soon as it's sold it goes off the radar (and onto another distant monitoring list, only to rise again 2 weeks later). A good method is alarms/alerts and charts, but you can't put an alarm on everything ! I think alerts are more important than monitors.

Often it is a case of being in the right place at the right time to notice something happening, or happening to read some comment which sparks activity. I use ADVFN and IG Markets' L2 Dealer which work fine most of the times. With ADVFN you would set, say, 4 alerts per share. Bid up by n, Bid down by n, Offer up by n and Offer down by n. If you're interested in volume you could set up one of those up too. I then use the Alert Agent to 'kerching' when any stock moves by the given amount. This works quite well on MarketMaker stocks but can be difficult on SETS stocks. For SETS the movement amount has to be set more carefully. I tend to use Sharescope chart alarms for SETS. I draw my lines, set the alarm and sit back and wait. I used to have all the alarms sent to my email but frankly it became too much to manage. I now accept that if I am out I miss stuff.

Q. How does one select which stocks to invest in?


A: How do we find our share ideas? From anywhere really. Say, if I come across thta someone mentions on an investor board or whilst I am travelling I see a company I like or product etc, or whilst talking to someone, newspapers and there are also ones that pop up in Investors Chronicle / Shares Magazine occasionally that might be worth a research etc. I then apply my filter rules to it which may take a few minutes and then decide whether to delete it forever or if it doesn't interest me yet i put it in one of the 'sector' monitors for later research. If its interesting I keep it on the main monitor and carry on the research having it ready for timing the buy.

How do you research shares? Your first task is to assess a company's operating performance. Simply put, is the firm profitable, cash-generative and growing? If the answers are yes, yes and yes, then the search for a good investment is off to a fast start. What is the company's strategy? Growth by itself is not a strategy. Growth follows from a properly implemented strategy that delivers shareholders value. Strategy is about competitive advantage, barriers to entry, market share and pricing power rather than driving sales and profits higher in a random way. 'Good' candidates benefit from high barriers to competition entry, have good future growth prospects, healthy balance sheets, are managed by sensible managers and operate in an industry free of government interference.

So for instance the research for a mining company could go on something like this -:
  1. Political risks?
  2. If explorer rather than miner, how difficult is the metallurgy?
  3. If explorer, do they intend to go into production or are they just beefing up a project for sale?
  4. If explorer planning to mine, how good are infrastructure and power requirements?
  5. If planning to mine, how likely are they to get environmental and mining licence?
  6. Is the mine open-pit (cheaper to mine but usually low grade i.e. less gold per tonne) or underground (more expensive but often higher grade)?
  7. What is the resource, broken down by measured, indicated and inferred?
  8. How much money to convert indicated to measured and inferred to indicated?
  9. Where is the money going to come from?
  10. Is existing resource JORC compliant?
  11. Is a feasibility study required, how much will it cost and where will the money come from?
  12. What is the timing of the scoping study or feasibility study?
  13. Where mining, what number tonnes of ore being processed, expected grade and recovery rate?
  14. Fixed costs of mining?
  15. Variable costs of mining?
  16. Anticipated cost per oz of mining or most recent costs if mining?
  17. Difficulties e.g. flooding, local resistance, maverick miners
  18. Taxation rates?
Note also that investing is a different animal to day trading where you buy and sell the stock a short time later. Here, you can compare traders to hunters and investors to farmers. Day traders watch the markets and monitor their trades the entire time the market is open, looking for short, quick movements in a stock to get in and out and for them the fundamentals won't matter much as they will base their trades on technical factors. Their success highly depends on skills and also luck. Investors on the other hand would do well to look at businesses with established operating assets that are cash generative, that have good balance sheets and cash flows paying attractive yields, have good interest coverage, and are not spurious or conceptual of nature. Here, it is worth noting that growth through increasing sales, acquisitions and/or innovation are important but you need to consider other risk factors such as the amount of debt the company has taken on. The success of investors depends on patience and the prices paid for the shares.

Charles Schwab for instance assesses a stock on the basis of four key areas: the share fundamentals - such as P/E ratio, dividend yield and return on equity; momentum; valuation; and risk. Momentum examines at broker changes, a firm's track record of positive earnings-per-share and its performance in relation to the market. Valuation takes into account a company's profit and loss figures, its balance sheet and short seller propensity.

A good way to uncover new opportunities is through the use of a stock screener which allows you to filter lots of shares and identify the ones that meet your defined criteria. For instance, you could scan all blue chip shares (say FTSE 250) with a prospective P/E ratio of less than 10 and a forecast per share (EPS) growth of 10% or more which could potentially output a number of modestly priced stocks with future potential. Here it is worth noting that the search capabilities of the different screening programmes available on the market does vary and you generally get a higher level of capability with paid-for services (Sharescope, CompanyREFS..etc) compared to free screeners.


Trading Stocks and Shares

Here are some guide points and key indicators to check -:
  1. Filter the shares in Sharescope or otherwise.
  2. Dump the c##p by this I mean spreads of 6% plus not there's anything wrong with stocks like that but on margin can be suicide. AVOID ILLIQUID STOCKS.
  3. Look at news flow, google news, and look at broker recommendations and tip sheets (don't take much notice of these they can be wrong also one lesson I learnt in early years).
  4. Get the list place all on monitor list and for me on Capital Spreads.
  5. Set alarms on all points of entry and stick to it rigid unless volume etc dictates.
  6. Set the stop for me dont like too tight but depends on time frame day, week, month...etc
  7. Set alarms for exit put a price in what you would like and then maybe move stop up.
  8. Hope this helps but for me it has took a few years to master and it seems to be paying dividends fingers crossed.
P.S. on the graphs put up sector which the stock is in, gives an insight to whether the stock is bucking sector growth etc...

I am currently monitoring about 50 stocks, most of which have to pass my 'selection test' which is:
  1. Directors/Chairman have to have bought large amounts of shares in the stock recently.
  2. Market Capitalisation is less than £100m.
  3. PEG ratio is less than 0.7 (although this is wavered slightly if, for example a stock is on the verge of breaking out -- or you just have a "feeling").
  4. The PEG Ratio has been under 1 for 3 of the last 4 financial years.
  5. EPS has risen by 15% or more in 3 of the last 4 financial years.
  6. The company is making a profit.
  7. The company has no/few/competitors/is the market leader.
If the stock more or less (I say more or less, because there are obviously cases where your intuition over-rides the criteria specifically - and you may feel that a stock is more of a "trading stock" so you're more concerned with very short-term moves, as opposed to being happy holding for a long time) satisfies all of the above, then they are added to the monitor. I used to view Directors'/Chairman deals as particularly significant, but I have found that although they do influence short-term movements, the other criteria is far more important over the long-term -- growth; growth; growth. Nothing exceptionally speculative.

I also trade in stocks that (satisfying most of the selection criteria) are on the verge of a chart break-out. This method has proved most successful for me over the years, hence if a stock is about to break-out and it at least possesses the 0.7 PEG Ratio and is making a decent profit, I will trade it regardless. I never deal in Biotech stocks (most of the ones I've put through 'the test' don't come anywhere near satisfying the criteria anyway as most of them are hemorrhaging cash, hence are not making a profit) and I tend to veer away from stocks that are affected significantly by interest rate changes.

Obviously there are occasions when I just have a gut feeling about a certain stock, but 90% of the time, my trades are executed bearing in mind my selection criteria - at least this way, if the trade goes awry you can sleep at night knowing that you're going to benefit from holding quality stock - not just some cash-depleted pile of garbage that is never going to return to the price you idiotically paid -- this has obviously happened to me in the past, hence my complete tightening of the strings when stock-picking. Losing money makes you learn how to make money. I have lived by the adage of "It doesn't matter if you make mistakes -- provided that you only make them once". It is a salient one to bear in mind, I feel.

Note: There is a limit to how many trading positions you can monitor effectively. It's roughly 15-20. There is a fallacy that, the more things you trade, the more chances you have to make money. As that would also mean the more chances you have to lose money, the sheer number of different positions is never proportional to your success.

'You may have heard of the 80-20 rule, to recap it came from an Italian economist Vilfredo Pareto, who observed that 80% of the land in Italy was owned by 20% of the population, it also occured to him that 80 percent of his peas were produced by 20 percent of the peapods. To summarise 80% of the results come from 20% of the efforts. It really isn't important what numbers you apply, what is important is that you understand that in your life there are certain activities you do (your 20 percent) that account for the majority (your 80 percent) of your happiness and outputs. If you want to be a profitable trader forget about learning 100% and spending 14 hours a day glued to a screen, just learn the important 20% and you will be at 80% of all the professional fund managers that's the principle in my own trading' - Vince Stanzione

Remember that the principle of diminishing returns applies here too...there is a fine line between getting things accurate and getting so accurate that it really isn't worth it. Knowing how precise things need to be can save a lot of time and effort...

-> 10 minutes shoveling a 20 foot walkway: good.
-> 15 minutes shoveling a 20 foot walkway: excellent.
-> 30 minutes shoveling it: weird.
-> 60 minutes: not good.
-> 2 hours: dude, step away from the shovel.


Q. So tell me what study and research would you suggest one does?

A: Here's an idea for you. Throw a dart at the FT six times and trade the six shares you hit (if they are under £1 throw again) on paper if you must (I don't believe in paper trading). Trade them in the direction of the current trend using a simple channel as per the sort on the recent charts I have put up. If there is no clear channel, throw again. Remember to employ the money management techniques described last week.

I did this in 1988 with a group of friends. We monitored the 4 portfolios over a year. We were not allowed to buy or sell, so not quite the same. Anyway, 3 out of 4 random portfolios beat the market. We had a control group of stocks we thought would go up. It went down.

Accurate research and knowledge of what you are investing in is probably the largest stumbling block. Having worked in the 'markets' I can tell you that you will be at a serious information disadvantage and I would be wary really of share tips you read in the press....journalists get those from analysts and frankly there are lots of awful ones:

- Are you prepared to pay $1000 a month in order to have real time quotes and access to the best software?
- Are you prepared to call the management team of every stock you invest in at least twice a quarter for an update?
- Are you prepared to read every available annual and quarterly report, results call transcripts and presentations on a potential investment, their competitors, customers and suppliers?
- Are you prepared to pay for access to every investment bank's research?
- Are you prepared to pay consulting fees to industry experts in order to understand current and future trends?
- Are you prepared to build a proprietary financial model, including P&L, balance sheet and cash flow on every investment?

Because your competition will. And most of them still lose money. So why not just give me the money or spend it on hookers and coke. At least you will enjoy that. ;)

Honestly, I'd start by finding some large companies that you are interested in and read up on them as much as posssible (you can get some information from the investor relations section of most companies websites) and then read up on all their competitors. Try and critique the business models of each company and also ask yourself if you think management are doing a good job. To make life a bit easier pick something you are interested in or companies that you are already familiar with.....as that helps. To help with the above you will need to read up on how you look at a company's balance sheet and what the key items to look for are. The latter depends on the business they are in. It's a LOT of work... Sometimes its even a good idea to actually visit the company premises or offices as it will give you a chance to see how efficient a company's operations are run, and get an idea of the corporate culture and how well the board's strategy and plans are understood by the firm's staff.

The idea is to take calculated risks based on research, charts and the fundamentals of a company. In the end you will find that in the long run well run companies tend to grow and poorly run ones tend to fail/merge. All things being equal though it may take the market a while to catch on to this, which is where hours of research and pouring over financial records comes in handy. It's a pretty simple formula but it seems to work well.

I also firmly believe that trade management is far more important than anything else. It is the most important lesson I have learnt. On any one trade that I take, whether it is in my SIPP, ISA, trading account or spread betting, I only ever risk between 2% to 3% max on any one trade. I have learnt my lesson and if the trade isn't working then I get out, simple...

So it is not a question of being right or wrong on any one trade more importantly is the trade working or not and if not exit quickly! Perhaps a problem with my strategy is that sometimes a stock will be marked down prior to news, so you will be taken out of the trade and not in for the re-rating but preservation of capital is key and in this market it's been the best way to run a portfolio, mind you there is no perfect way to trade, too aggressive and you will get hurt in a downturn, too cautious and your likely to miss a big upturn in your stock of choice!

Note: I find it easier to maintain interest in monitoring a stock if I'm in it rather than merely listing it as a prospective play. If I'm temporarily exiting something on which I've had say a £25pp bet, I will sometimes reduce to £1pp rather than to zero (but with a stop in place on that residual stake), just so it holds my attention better! I think of those minimal holdings as being in 'nursery mode'. A bit like a pilot light.

Q. How important is free cash in selecting a company to invest in?

A: For instance a lot of companies in the construction sector report high levels of cash but it is not free cash. Its money they hold in up front deposits and stage payments on large contracts. If they combine this with late payment to suppliers they can give the impression of a large cash reserve whereas in fact they cannot use this cash for dividends or acquisitions. There is a big difference between a cash rich retailer and a cash rich construction company. It needs digging deep into the accounts to see the real picture - something I'm personally not very good at and very time consuming.

A few thoughts on the most obvious crosschecks with how much a company holds in cash are:

  1. ADVFN gives details of net cash as well as cash since indebted companies are not always free to fritter away their cash.
  2. ADVFN also gives cash flows.

Careful study of how much a company owes and when the repayments are due is also essential and these details are all available in the financial reports of the company.

My method is to average the cash flows over the last 3 years and report them as healthy-like positive for instance-or unhealthy. Generally my metrics ignore whether current assets happen to be held in the form of cash unless the company has blown large sums on 'intangible assets'. If the company has excess cash reserves and has chosen to punt them on acquisitions then I don't chuck them out of the watchlist; if they have borrowed money 'to overpay for acquisitions (i.e. goodwill arising upon consolidation) in order to boost apparent sales growth' then I am out of there.

Q. How do you measure how cheap or expensive a share is?


I've seen various measures of how cheap or expensive a share is. Many seem to use a rule such as market cap should be less than ten times profits. So why isn't everyone piling into shares such as BP, Shell, BHP Billiton and Carnival whose market caps are barely more than a year's pre-tax profits?

In a book I read a suggested rule of thumb is to avoid companies whose debts are more than three times their profits and the lower the better but I keep seeing tipsters (who I'm learning to ignore!) tipping large companies that to me appear to have very high levels of debt. What am I missing?

A: Response by technical analyst Henry Atkins. Rules of thumb are not to be relied upon. The market capitalisation rule says a company is never worth MORE than ten times earnings. That is not the same as saying it IS worth ten times earnings. If you look at the accounts of a company like SDR you will see that it holds cash of half of the value of its market capitalisation so you would have to deduct this cash from the market cap before applying the max ten times earnings rule.

Companies with consistent high Return On Equity, high Return On Capital and high margins will always command a higher rating than companies with low returns & low margins. It's all about risk. So you can start by saying a company's share price should be around 10x earnings per share (EPS). But look at two different companies and see the difference in share price. To get this into perspective at the time of writing Latchways (LTC) [this is not a suggestion to buy Latchways btw!) is a company that has patents on its products and manufactures (amongst other things fixings and equipment for high rise buildings securing window cleaning/inspection rigs. They have the market almost to themselves and have maintenance contracts to back up the capital goods. Operating margins are 22% (lots of room for a downturn), ROCE is 52% and ROE is 26% (that's more than double the average FTSE returns). They also have cash in the bank - no debt. The share price trades at almost 20 times next year's forecast earnings per share. Now compare that to a similar company in a similar sector Low and Bonar (LWB). The share price is less than ten times EPS, the operating margin is only 5.7%, ROCE only 11.8% and ROE just 3.7% - you would be better off in a FTSE tracker fund. All of LWB's figures get worse year after year but LTC's figures improve year after year and LWB carry debt. There would seem to be a fair chance that LWB will eventually go bust. So would you buy LWB because they are cheap or LTC who are much dearer???

Note from editor: I have also learned that the king ratio, is the price to book value and that if you buy a sustainable business (not a blue sky start up) that is selling below book it will likely not go down much and will in the by and by reward me. But it doesnít always work. QED was a recent failure where the drop in price through long established support and the prior failure to move off that support led me to believe something was wrong and so itís gone. Clearly I ought to have held on based on its fundies, but I have also learned that if the share price doesnít reflect the fundies over a reasonable period it is time to go, one can always watch and re-mount if it starts to recover. But better would have been to wait for a market down wave to push the price down giving a better margin of safety.

Q. Is there a formula to work out if a company is under/overvalued?

A: Response by technical analyst Henry Atkins. Valuations are in the eye of the beholder. There are basically two methods of valuation - intrinsic and comparative. If I own an business I could sell it for a comparable price to a recent similar business that has been sold. If I can't find a recent similar business that has been sold I have to turn to intrinsic valuation which is the value of the assets, the goodwill (the good name and reliability I have given to the business) and a return on your likely future earnings (discounted cashflow). In its simplest terms you can compare PLC's by comparing price to earnings ratios (PER) within the same sector, price to earnings growth (PEG) or the market capitalisation to the book price. The book price is the valuation that the company and its auditors put on the company but it takes no account for future prospects. Most companies trading on a particular high/low comparitive valuation are doing so for good reason.

Here's something to ponder about. I've just finished reading Beyond The Zulu Principle by Jim Slater (give it a read). I read the original Zulu Principles some years ago but never followed it up with the latter book. It goes right to the top of my list but only on the assumption that you already understand the basics. The book explains how he filters the markets to obtain stocks that consistently out perform the index. Essentially he works on PEG below 1, cashflow per share greater than earnings per share and P/E ratio under 20. After that he looks at momentum on an annual, three monthly and one month basis. The one month and three months serve as a warning but the 12 month is an exit. He also looks at margins and competitive advantage. What he puts together are the tools for his Company Refs scan (Companyrefs.com) which is still available today on subscription and still outperforms the market in its stock picking. If you use Sharescope you can obtain all the information from their data so I presume a script could be written for SS Pro. Although he is not into charts the momentum rules can be visually charted by displaying the three momentum charts: 200 day period for 1 year (200 trading days per annum) 50 period for 3 monthly and 20 period for 1 monthly. Imo the 1 monthly gives too much noise. It works very similar to using two or three CCI charts of the same periods. To get an idea of what stocks it throws up across the complete markets CHG, CHW & SKYW (there are many more) are all current picks (January 2011) which should typically outperform the index by a good margin. Moving averages and MACD's etc go out of the window as far as exiting trades so it's a longer term growth strategy for those who don't want to kill their pot with over trading. I think that if you are into long term growth (I am) after a while you pick many of REFS type trades intuitively. If nothing else its convinced me to switch from CCI to momentum - after all if your stock doesn't outperform the index you might as well put your money in a tracker fund.

In any case one has to be flexible as even Slater himself doesn't staunchly stick to his criteria (say how much net debt to allow for versus profit). You have to look at the whole picture and if some criteria aren't as good as you would like but others are strong it shouldn't put one off researching.

Q. How can I compare market capitalisation against profits?

A: About comparing market capitalisation with profits try this: use the FTSE 350 to plot companies with market capitalisation between 50-1000 million (x axis) against pre tax profits £5-900 million (y axis). Also, filter out companies with too much borrowing. Then imagine a straight line representing the ratio cap/profit = 10. Last time I did this there were 35 companies above that line (i.e. capitalisation/profit).

Q. What is 'Beta' in a share?

A: A stock's beta is a measure of a stock's volatility in relation to that of the main stock market. So beta is a measure of a security's correlation/independence to the market, and the extent to which it exaggerates the moves the market makes, or ignores it altogether. For instance a stock with a beta of 2 will move 2% for each percentage (1%) move in the main market.

So going for a stock with a low Beta would be very conservative since if the market fell sharply the stock's price would not be affected that much. Of course if the market were to experience an upward surge the movement in the stock with a low beta would that be as good as the high beta shares. Critics maintain that Beta is an indicator based on past performance and may not always be valid for the future, however it is still a useful tool... Beta can misleading for individual stocks, although it has some value when measured for a portfolio on a whole. As a straightforward volatility measure, a stock can be volatile and yet avoid any kind of correlation to the overall market, so it's a tricky one.

For myself I think one of the biggest problem with beta is with an individual's trading style. We should all have a different beta figure because we trade different timeframes. ADVFN, Sharescope and Digitallook don't say over what timeframe their calclations are taken. Even if they did it possibly wouldn't align with yours. You really need to personalise your own beta on three measures: your trading/investing timeframe for holding stock, its comparison to the index and its comparison to your portfolio.

Note that for indices a beta rating of 1.0 indicates an index will move in line with global stock market indicators. Betas of more than 1.0 signify more volatility, while those below 1.0 less.

Q. How can a sector help you find performing stocks?

A: One of the keys to selecting trades that perform is to understand market direction and sector direction simultaneously. In fact before you consider buying (or selling) into any stock you should study the industry group to which that company belongs to check -:

  1. How the stock is performing against its sector group (is it out-performing or under-performing our sector?)
  2. Whether the direction of the sector corresponds to the direction in which you are considering taking a trade (for instance it is dangerous to short a banking stock if the whole banking sector is in recovery mode.
  1. Sector Analysis to Find Performing Stocks -:
  2. Find Performing Sector
  3. Create list of Performing Stocks (stocks making new 52-week highs for long trades or 52-week lows for potential short candidates)
  4. Use Combined Signals to Buy and Sell
  5. Establish a Risk-Reward Ratio (minimum 2:1)
  6. Risk Manage every trade.

So first establish the sector direction and then filter down for stocks that are highly correlated to the movement of the sector. Such stocks will react strongly to any movement in the underlying sector. It is quite helpful to understand the beta correlation of the stock in relation to the sector here as that will provide you with an idea of how much the stock will move for each point movement in the sector. If you are a contrarion you could even consider the laggards as potential undervalued shares but usually it is more prudent to stick to those shares that perform well with the sector.

Q. I'm looking for tips on how to guesstimate a target share price...?


I'm looking for tips on how to guesstimate a target share price, do you set a target based on a percentage (20% in 12 months) or do you look at company x and say I reckon its worth £5 and its selling at £4...

A: Let me attempt to give you an answer that will address your question. If I'm trading a stock then I might look for setups that will deliver 3:1 risk reward. That is to say, I am prepared to lose £1 in an effort to make £3. Chart setups and indicators are the only way to do this.

On the other hand a value investor will pull out some baffling formula and tell you that they think MKS is worth X, Y or Z but he won't be able to tell you when it might reach its valuation. He will plunk his money on and wait (sometimes with stunning success).

So the proper answer to your question is that you have to know how to value a company and how to read a chart. Once you can do that then you can begin to guess where something might be in the future. Trouble is, even if you can do both, it doesn't mean that the stock will do what you think. Ask MDX holders...they just weep and buy more of a stock that refuses to rise as they expect.

Suppose you are a trader looking to trade stocks over weekly timeframes. To start with you would do well to seek liquid stocks that are fairly volatile [say 5 to 15 per cent move (up or down) over a two-week to three-month time frame] To do this you would use scanning programs - in particular check the average true range (a measure of how far a share has been moving on a day-to-day basis) or you could simply look at charts. Check whether the stock is in an uptrend or downtrend - an uptrend would involve a series of higher highs and higher lows. In particular, are the moving averages showing positive momentum? Momentum defines the strength of a trend, as measured by the ratio of the size of rises in relation to that of falls.

Check things like key support and resistance areas. Support is an area on a chart where a declining share price was met with buying support, thus stopping the decline and eventually leading to a recovery. If this occurs more than two times at the same price level, a support line will have formed and the stock is likely to have trouble breaching that price level in future. Resistance is the opposite - it happens when a rising market meets buying pressure and the price dips returning to reach the resistance level more than twice. For long positions you probably want to place your stop loss level just below the support level. This will reduce the number of bad trades while improving the probability of success.

Shares Magazine quotes a good example where you could use support and resistance levels to trade BP stock. Once the company recovered from April's disastrous oil spill in the Gulf of Mexico the stock price rose sharply. But since July 2010 it has been stuck between the support level at 360p and resistance at 440p. BP stock has tried three times to breach this 440p level but each time it has failed to breakout and close higher. This demonstrates that there aren't sufficient buyers to get beyond the area of resistance, albeit each time BP has fallen back it has found support at 360p. Josh Raymond, market strategist at CityIndex goes on to explain the technique for trading such a rangebounding market: If you buy at the bottom of the trading range with a tight stop loss below the support and then sell short at the top with your stop just above the resistance you can look to capture the full movement from bottom to top and then back again. BP hit the top of the range at 440p on Friday 1 October 2010. Using this technique it would have been possible to sell short with a very tight stop to buy just 1% higher at 444p. The profit potential on this was the best part of 80p, some 18 times bigger than the possible loss.

Resistance

Since July 2010 BP has been trading between support at 360p and resistance at 440p.

Q. How does corporate news affect the price of stock prices?


The question is... should I buy some more CSR today before results, or tomorrow on confirmation of excellence? I think the latter.

A: I rarely buy on news, because in at least 7 times out of 10 cases (at least on the - market-maker - stocks I trade), the price is marked up before I can buy, rarely then going up much further, and then is gently (or not so gently) dropped, leaving yours truly nursing a loss. What is important is the ability to react appropriately when not first in the queue for that news.

If a positive news release is timed at say 12:15pm, and you see it at say 12:17pm, how long have you got before the news-driven reaction reverses and it's no longer worth clambering aboard? How long before the next wave of positive reaction kicks in? On a stock held mostly by big-volume institutional players, the pattern will differ from that of a stock held mostly by thousands of private investors.

The old saying "Buy on the rumour, sell on the fact" has a lot of merit IMO.

But the best way to answer the question you posed is to trade. And make mistakes. And then analyze and learn from those mistakes. And then refine your system to reduce the mistakes. And keep on, endlessly, patiently, plugging away, until you have a system that works for you. No-one else can do that for you IMO, even though we can give advice on particular points (e.g. how far away to place stops).

I suspect that most traders learn to trade this way - and are still refining their respective systems. I honestly think that you can learn a lot more from doing it yourself than endlessly reading what others have to say on the subject - useful though the latter undoubtedly is.

Q. In 2007, JSG share price was trading the in the range of 300-400p - now its 30p surely it could head towards there again?

A: Don't take this the wrong way, but this is highly unlikely...for example take a look at JPR - they were trading at the 500 mark about 3 years ago and are currently around 10p... a rights issue diluted the shares putting more shares onto the market so this is not a good guide to future performance. Looking at JSG's debt is 64.6 million and the profit is 8.4million...so using a quick x3 debt calculation this is well over x3 profit to debt, it is 7.6 times. It is not the be all and end all way to value something but it is a quick and easy calculation to do before doing further scrutiny.

Q. How do stock prices usually react to an upbeat trading results market update?


I bought shares in MRO when they were 93.5. They're now 129.4 following a very upbeat trading announcement a few weeks ago. Now their interim results are due on 28th August and I'm wondering what sort of effect this is likely to have - particularly after witnessing the effect of Lloyds' and RBS's recent statements on their share prices.

I'm tempted to just take the profit now and be grateful the sp grew so much, particularly since I don't like any of the other figures for MRO but I'm interested in your thoughts on the effect of such statements generally. The effects of the recent announcements by the banks make it look like gambling to me.

A: Often good news is anticipated and the price rises up to results day but when the good news is announced the price falls. We get from this the mantra: buy the rumour, sell the fact. That doesn't apply here as we already have the 'news'.

MRO (Melrose Share Price) has announced that all is OK and so the existing news is most likely already reflected in the price. What the results will contain is some future guidance; this can make or break the price and you must take a view on what you think future guidance will be.

The chart looks lovely and if I were a holder I would have a stop at 123. No advice intended, for education purposes only, I am not qualified to give advice...

Melrose Share Price

Melrose's chart looks lovely, however often good news is anticipated and the price rises up to results day.

Q. Should I get out of a stock, even very short term to later buy back in after profit taking, on a results day?


Obviously it's very statement dependent, but what do you tend to look for with regards to things you see in the time and sales window or the order book that would tell you things may be heading for profit taking that day?

A: It can be a bit of a coin flip before an announcement. In that situation I will often take half off prior to results. This banks some profit and reduces the overall risk - if the share rises then you still benefit, if the share falls you are less exposed and have the option of buying the half back you sold for less cash - often good companies report good results and the share price drops - buy the rumour, sell the fact. On the the plus side, assuming news is decent and you want to be in for the longer term, a pullback can be seen as an opportunity to add at an appropriate moment. It really depends on your plan for the share, but taking half off beforehand is a good way of limiting any downside.

Q. Is it a good idea to buy more of a stock that's doing well before it gets too expensive or hang on to my cash until another opportunity arises?

A: Ah...Well... Maybe. There are all sorts of different strategies and tactics that investors employ to best achieve their goal. Some insist that loading a winning holding is always the way to go. That 'the trend is your friend' and should be taken maximum advantage of while it can be. But every new purchase is opened at a loss that has to be overcome (the dealing fee, stamp duty, bid/offer spread), and this setback can dilute or totally demolish whatever gain is already made in the existing holding. So you need to calculate this effect, or you might find that you end up keeping none of your gains if forced to sell just after you've again diluted away your profit. The trend is your friend 'till the bend at the end'. If the trend does expire, each new day will have been one day closer to that happening, and personally I don't like being in possession of my biggest stake when it reverses. I do sometimes double or treble my stake in a stock that is going well, but I do it as early as I can identify that it's a worthwhile idea. And I will bank some of the earlier gain from time to time (think of the process used in The Weakest Link!). This is not an approach that is viable with small accounts where trading costs are proportionately expensive. If I get to a stage where an investment has doubled, I will sometimes sell half, thereby recouping my initial outlay so that the ongoing holding is 'free'.

 ...Continues here - Researching Penny Shares


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