Trading ideas: MagicFormulaInvesting.com

Normally, I’d be turned off by a website that has the word “magic” in its title. But this website is very different from any you’ve visited.

MagicFormulaInvesting.com is the brainchild of Joel Greenblatt, a successful hedge fund manager. The “magic formula” that the site’s title refers to is a simple quantitative ranking that Greenblatt developed. This formula assesses securities by two measures:

• A cheapness measure: Similar to the inverse of the P/E ratio
• An efficiency measure: Similar to the return on equity ratio I describe in Chapter 8

Greenblatt, who wrote a book about this formula titled The Little Book That Beats the Market (published by John Wiley & Sons, Inc.), found that ranking securities solely on these two criteria generated a list of candidates that mightily outperformed the overall market. The formula is geared to long-term investors who are encouraged to hold stocks appearing at the top of the formula’s rankings and update holdings at least annually.

So how can a long-term investor-type formula serve any purpose for the swing trader?

Well, as it turns out, these stocks are often great places to find trading ideas. Although Greenblatt encourages his readers to be patient and wait for promising candidates to start generating healthy returns, swing traders can simply buy those candidates that are beginning their rise and avoid those that have yet to turn around.

The website — which is free to use after you register — allows you to view the top-ranked securities above a certain market capitalization you specify. This makes screening for highly rated small cap stocks or highly rated large cap stocks a cinch. After registering for the site, you’re asked to enter the minimum market cap of the securities you’re screening for and the number of top-ranked securities you’d like to view (30 or 50). After clicking on “Get Stocks” the screen generates the top-ranked securities meeting these criteria.

MagicFormulaInvesting.com is a bottom-up screen that looks only at fundamental criteria to identify promising securities. You can start using the screen today by logging onto www.magicformulainvesting.com.

Trading ideas: High Growth Stock Investor

High Growth Stock Investor (HGS Investor) is a software tool that assists in identifying promising candidates to buy. The software incorporates both fundamental analysis data and technical analysis data. The software can be used to identify securities using both a top-down and a bottom-up approach.

What I like about HGS Investor is its efficiency. Inside of five minutes, I can determine the overall state of the financial markets and where the strength or weakness is, industry-group-wise. This makes my job easy because I can simply look for investment candidates in the strongest industry groups in the market.

To assist you in identifying which industry groups to analyze, HGS Investor color-codes industry group rankings. Industry groups performing in the top 20 percent of the market are color-coded green. The next 20 percent of industry groups are color-coded yellow. The industry groups ranking in the bottom 60 percent of the market are color-coded red.

HGS Investor also allows you to analyze commodities, dividend-paying securities, international securities, and value investments. Though some traders use HGS Investor for longer-term horizons than swing traders typically would, the software can be extremely valuable for the traditional swing trader.

You can get a free trial of HGS Investor by visiting the firm’s website at www.highgrowthstock.com. An annual subscription costs around $700.

Trading ideas: eTables by Investor’s Business Daily

Investor’s Business Daily (IBD) had a major impact on my investing life. Back when newspapers were still purchased at newsstands or bookstores, I would buy a copy of this financial newspaper, read it cover to cover, and digest all of the rankings offered for each security. IBD, unlike other newspapers, was geared to the swing trader. The newspaper offered stock ideas daily and combined fundamental and technical criteria in its quantitative ranking measures for nearly every company that trades in the United States. IBD often highlighted small cap companies generating strong earnings growth and flying under the radar screen of most asset managers before they generated huge gains.

But the newspaper industry is a dying breed and IBD has established powerful online tools that you should consider using.

eTables is a service that allows you to review the best ideas from the editors of IBD (such as IBD New America or IBD 85-85, a list of securities with earnings per share and relative strength rankings of 85 or better).

eTables also highlights securities that have just emerged from bases and may be ripe for purchase. The company’s philosophy is built around the top-down trading and emphasizes strong industry groups and strong stocks within those groups. The service favors growth-oriented securities over value-oriented securities.

eTables can also assist you in selecting companies with strong fundamental and technical criteria, such as the following:

• Earnings per Share Growth Rating: This fundamentals-based ranking compares a firm’s earnings growth history to the other companies in the market. The higher the earnings growth relative to the overall market, the higher the EPS rating. The scale runs from 1 to 99. As a swing trader, you should focus on buying companies with EPS ratings of 80 or higher.
• Relative Price Strength Rating: This may be viewed as a technical ranking because it compares the price performance of a security to all securities in the market. The higher the rating, the better the security has performed relative to the market. The lower the rating, the worse the security has performed relative to the market. This scale also runs from 1 to 99, but you want to focus on buying companies with RS ratings of 80 or higher.
• SMR Rating (Sales + Profit Margins + Return on Equity): eTables attempts to simplify fundamental analysis for you by crunching these figures and generating a grade of either A, B, C, D, or E. Of course, an A rating is assigned to companies with superior sales growth, profit margins, and return on equity ratios as measured against other firms in the market. Swing traders should focus on buying companies with a rating of A or B. Avoid buying companies with a rating of D or E.
• Accumulation/Distribution last three months: According to IBD, this rating measures “relative degree of institutional buying (accumulation) and selling (distribution) in a particular stock over the last 13 weeks.” Translated into English, this rating looks at whether big investors are buying shares en masse or selling shares en masse. Although IBD doesn’t disclose the actual formula, it’s safe to say that the measure compares volume on days a security closes higher to volume on days a security closes lower. As with the previous rating, stick to companies with Accumulation/Distribution ratings of A or B and avoid buying companies with Accumulation/Distribution ratings of D or E. Stocks rated C are showing neither strong accumulation nor strong distribution.
• Composite Rating: Finally, eTables publishes a Composite Rating that sums up a security’s score on the aforementioned criteria and adds in a security’s industry group ranking. The Composite Rating ranges between 1 and 99. As with the Earnings per Share Growth Rating and the Relative Price Strength Rating, I recommend buying stocks with an IBD Composite Rating of 80 or higher.

You can subscribe to eTables by visiting the IBD website: www.investors.com.

Charting software: TradeStation

You can find dozens of charting programs on the market. I’m partial to TradeStation, the software used for many of the charts in this book, because of its seamless integration of charting and trading.

TradeStation is more than just a trading software tool. When the company was founded, charting and indicators were its bread and butter. TradeStation allows users to tap dozens of indicators that come prepackaged in the program or design their own trading indicators. By using those indicators, you can develop and backtest your trading strategies.

TradeStation now incorporates brokerage with the charting platform. It allows users to trade public equities. What I appreciate about the program is the ability to monitor positions in real time and put trading alerts on every position I hold. For example, if I own shares of Amazon and want an alert if shares trade below $1,500 per share, I can automate that in TradeStation and have an email sent or alert signaled when my criterion is met. I place such alerts on every position I hold and on candidates I’m looking to trade.

TradeStation has won broker awards from the financial newspaper Barron’s and the trading magazine Technical Analysis of Stocks and Commodities. You can learn more about the program by visiting www.TradeStation.com. The TradeStation platform is free to brokerage clients who do a minimum number of trades a month (check with TradeStation to find out what that minimum is).

Charting software: StockCharts.com

StockCharts.com was founded in 1999 and offers users free charting services as well as premium services for paying members. Free charting features include the following:

• Three indicators per chart
• Three overlays per chart (referring to indicators plotted on top of the price movement)
• 900 pixels maximum chart width

Members who pay a fee (ranging from $14.95 per month to $39.95 per month as of the date of this publication) receive the following benefits:

• 25 indicators per chart
• 25 overlays per chart
• Real-time data
• Larger charts
• Custom scans
• Custom alerts on individual stocks

StockCharts.com also features a “ChartSchool,” which provides educational resources in charting analysis, technical analysis tools, and scanning tools.

Real Vision TV

Real Vision was launched in 2014 to disrupt financial media. The subscription-based website offers streaming videos of the brightest minds in investing, economics, and trading talking about their insights and opinions. All interviews on Real Vision are proprietary (you can’t access them on other platforms) and the interviews offered on the site are more in depth than comparable pieces on mainstream financial news networks (for example, an interview with a legendary trader like Jim Rogers may last two hours).

Real Vision is an ideal resource to find out about different parts of the world and hear different views on topics like the likely direction of equity markets, currencies, interest rates, and so on. The site doesn’t cater to one type of trader or investor. Instead, you’ll find views from shot-term traders, long-term investors, and everything in between. When there is a new topic you want to read about (such as Bitcoin), Real Vision has experts debating the topic.

I like to watch the videos while I’m ironing. I always find I discover something new in each video. Real Vision interviewed me once for my views on investing.

You can subscribe to Real Vision TV for $180 per year.

GMO Research

GMO is an investment management firm based out of Boston and founded in 1977. As of the date of publication of this second edition of this book, the firm managed $70 billion.

GMO is an institutional asset management company — meaning the firm manages money for large organizations like insurance companies, sovereign wealth funds, and pension plans. GMO is a fundamentally driven investment firm; the experts who work there are driven by extensive analysis of earnings, interest rates, valuations, and so on. Their investment horizon is measured in years, not weeks.

So why would I recommend you read this research? In short, GMO’s calls on the long-term direction of markets are more often than not correct. They’re focused on larger moves than what may happen in the near-term.

Because swing traders are focused by definition on shorter-term trends, it’s useful to expose oneself to the thinking of long-term investors who capture large, secular trends. Don’t expect that GMO’s free research will give you trading ideas. Rather, it’s useful to know the stage of the economic cycle and whether equities are expensive or cheap. That way when a swing trader sees trends emerging that align with the long-term picture GMO focuses on, she can position the portfolio to take advantage of the long-term picture.

You can subscribe to the research for free by visiting www.gmo.com.

Yahoo! Finance portfolio tool

The easiest way I’ve found to keep tabs on all the news on my positions is to use the My Portfolio from Yahoo! Finance. This tool allows you to quickly enter the symbols of your portfolio holdings and even link the site to your broker or brokers’ systems. After the symbols are loaded, the tool pulls down any news headlines associated with those symbols, sorted by date, from such sources as Bloomberg, Reuters, and company press releases. By checking this website on a daily basis, you can stay on top of company announcements (such as earnings dates shown in the Events tab under the Calendars option in Markets) or positive/negative mentions of your securities in the popular press. I can quickly stay on top of a portfolio of 25 positions by using this portfolio monitoring service. And the best part is it’s free.

To see the portfolio tool, visit Yahoo! Finance at http://finance.yahoo.com. Then click on the tab labeled My Portfolio. You may need to sign onto Yahoo! or create a Yahoo! ID to uniquely identify you and your holdings. After you’ve logged onto Yahoo!, you can edit or create portfolios on Yahoo! Finance.

Yahoo! Economic Calendar

On almost every business day, the federal government or private organizations release economic news that affects financial markets. Some of the information is very important (such as Federal Reserve Bank interest rate decisions), whereas other data points have little impact.

To keep yourself apprised of the important stuff, turn to Yahoo! Economic Calendar, which provides a listing of all major economic news scheduled to be released in any given week. The website shows what data is to be released and what the market expects the data to be. The calendar even provides coverage for global markets (such as Japan, the United Kingdom, South Korea, and so on). Some data is released before the market opens, and other data is released during market hours. Yahoo! lists the time of each release — so keep in mind you may see some early hours for Asian or European markets. I check the site at least once a week to know what major news items I can expect.

But how do you know when a report helps or hurts stocks? Follow these guidelines:

• Inflation: Generally, higher-than-expected inflationary data (in the form of the Consumer Price Index or the Producer Price Index) is negative for both stocks and bonds.
• Economic data: The growth rate in the country’s gross domestic product may be interpreted as bearish or bullish for stocks, depending on the stage of the economic cycle. If the economy is weak, then strong economic growth numbers are highly prized. However, if the economy is overheating, a strong economic report may send stock prices falling fast because investors will fear interest rate hikes that hurt companies’ profitability.
• Central Bank Actions: These actions (for example, lowering or raising short-term interest rates) tend to have the largest effects on financial markets. When the Federal Reserve lowers interest rates by more than market expectations, it generally leads to rallies in stocks and bonds. When the Federal Reserve raises interest rates by more than market expectations, it generally leads to declines in stocks and bonds.

If these financial terms make you woozy, don’t worry. You don’t need to become an economist to swing trade successfully. I just want you to be on top of the reasons behind market movements so you can position yourself accordingly.

You can access the Yahoo! Economic Calendar page at https://finance.yahoo.com/calendar/economic.

Real Vision Research

So much “research” is available online. How do you filter through the good from the bad? And even if you knew all that was good out there, how could you possibly have the time to read those publications?

Enter Think Tank, a research subscription offered by Real Vision. Think Tank provides a weekly digest that summarizes research from 30 of the leading independent research firms. Real Vision TV (refer to the earlier section in this chapter) offers streaming videos from some of the best minds in the trading universe. That same company offers Think Tank.

I recommend Think Tank because it’s

• Independent (unlike research published by the largest investment banks, which are selling something other than the research)
• Includes several different research publications (not a single firm)
• Offered at a reasonable cost ($365 per year)

Subscribing to each of the 30 investment research firms covered by Think Tank would be cost prohibitive; some of the research providers charge $50,000 per year. To offer a solution at a reasonable cost, Think Tank offers subscribers a weekly digest that summarizes the ideas from the 30 investment research firms it covers. In addition to this digest, Think Tank also provides two full research reports each week from the 30 firms it works with for those subscribers wishing to read the full reports.

Think Tank costs $365 per year. You can subscribe to it on the website, www.realvisionresearch.com/think-tank/.

Technical Analysis of Stocks & Commodities magazine

Technical Analysis of Stocks & Commodities is a magazine devoted to analyzing stocks and commodities from a technical perspective. The magazine is released monthly and covers charting, computer trading methods, and technical software products. The magazine also features interviews with trading professionals discussing their approach to the markets.

The magazine isn’t a resource for trading ideas. Rather, it helps traders improve their trading techniques by applying existing indicators or by using new ones. When computer code is necessary to implement an indicator that the magazine discusses, the formula or code is usually included. And I like the fact that figures are interspersed with the text to make concepts easy to understand.

You shouldn’t implement every strategy or indicator you read about in this magazine. Rather, look to refine your own systems by incorporating nuggets of information that arise from time to time. Your trading system shouldn’t change on a day-to-day basis (or month to month, for that matter). But the techniques you use can be refined if such honing improves performance.

To subscribe to or find out more about this magazine, visit www.traders.com.

The Black Swan: The Impact of the Highly Improbable

True knowledge is understanding one’s ignorance. Financial markets teach that lesson to thousands every day.

Nassim Taleb’s book, The Black Swan: The Impact of the Highly Improbable, colorfully educates readers on the risks of thinking they know more than they really do. The book’s title comes from the problem of induction, or drawing generalities based on particular events. For example, a scientist in Europe who witnesses thousands and thousands of white swans may come to the conclusion that “All swans are white.” However, just because the scientist never witnesses a black swan doesn’t mean that black swans don’t exist. (Black swans do in fact exist.) Similarly in trading, you can’t assume that certain events can’t happen just because they’ve never happened before. And you can’t assume that certain relationships must continue to exist in the future simply because they’ve existed in the past.

Though Taleb’s book isn’t specifically geared to swing trading per se, I consider it invaluable because it helps train traders to think differently than the masses on Wall Street. The book is also helpful in terms of a risk management perspective. You’ll be better able to manage your risk if you plan for extreme events and how they may affect your positions.