This posting is about some techniques that we have used to identify stocks for short term trading.  It is easiest to apply these when you have some software to scan a large number of stocks.  The technique of choosing a stock that is moving from underperforming to outperforming works better if can smooth out random price movements.

Use these methods at your own risk.  Remember to always set stop losses.

Oversold stock

You are looking for a stock that has been very strongly sold off, but still has strong fundamentals and was previously in an uptrend.  Typically the market oversells the share one day.  Once the market understands that it has overreacted, then share then rebounds.

You should preferably buy around the market close.  If you have access only to end of day data, buy just after the open.

You need to set a tight stop loss just under the previous low.  If the stock continues to sell off, you need to be out.

Typically the stock will recover during the day, so you should sell off that same day.

High relative strength stock

A high relative strength stock will rise by more than the market, and fall by less than the market.  It will tend to outperform the market over time.

The best high relative strength stock will be in a sector that also has a high relative strength as a whole.

You will need to measure relative strength over a longer period than one trading day.  Usually high relative strength can be maintained for weeks or months.  Look at price movement compared to the market index.

Similarly, you can short sell a low relative strength stock using the same approach in reverse – look for the weakest stock in the weakest sector.

Underperforming stock that becomes an outperformer

If you look at most leading stocks (that is, stocks that form part of the major indices), there are times when they underperform the market, and times when they outperform the market.  But overall, the stock performance tends to match that of the index (which is expected since leading stocks comprise the index.

So the time to buy them is when they are moving from underperforming to outperforming.  So the stock should have low relative strength at a particular point then higher relative strength afterwards.  Sell the stock when relative strength is less than that of the market.

This strategy is similar to statistical arbitrage, which relies on highly correlated pairs that may diverge, later re-converging.

Tags: stock market, stock picking, Stock Trading

This entry was posted on Monday, March 17th, 2008 at 12:23 pm and is filed under Trading Basics. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.