Trend Check with Tushar Chande

Organizing Your Trading Strategy By Trend Strength (Or, How to Make Sense of Jim Cramer's Stock Picks)


If you watch Jim Cramer's Mad Money show on CNBC for a week, you will hear about so many stock picks (symbols) that it might drive you crazy.  He spews so many symbols, that in a month's time you will  be easily overwhelmed.  So here is a useful chart to put into perspective any stock picks you encounter in the mass media or blogs such as this one.


Chart 1:  The stocks in the S&P 500 universe are distributed along a line stretching from lower left (weakest stocks) to the upper right (strongest stocks).  Many stocks are in a neutral zone, roughly stretching from 20:80 along each axis (see below).


Joint Distribution of Relative Returns and Absolute Trend Strength

We look at two issues: relative returns and trend strength.  In colloquial terms, how has the performance been relative to other stocks, and how does the chart look.  We can do that by charting the Stock Charts SCTR ranks against the Chande Trend Meter (CTM).  Remember that SCTR is organized by market cap, so all large caps are compared together as a group, all small cap stocks as a group and so on.  In other words, this is not relative performance versus an index.  Since SCTR is siloed by market cap, values should not be compared across market-cap or between stocks and ETFs. The Chande Trend Meter has no such limitation: it can be viewed as composite indicator that covers many chart features and time horizons, to answer the question: is this object (stock or ETF) trending irrespective of market cap?  Conveniently, both have a scale from 0 to 100.  For SCTR, a 99.9 rating means the stock had the best absolute performance compared to all other stocks in its universe.  A reading of 100 on CTM means the stock is trending up strongly (a reading of 0 means the stock is trending down strongly).  In the limiting case where all stocks are in a down-trend, there will be no stocks with say CTM > 70.  Also, in an extreme case, if all stocks are in a down-trend, the top ranked stocks via SCTR could have negative performance.   When I plot all the stocks in the S&P 500 universe at the same time, we get Chart 1.  This is a fairly typical distribution.


Trading Strategies

Once we can plot stocks as we did in Chart 1, with the strongest stocks to the upper right and the weakest stocks to the lower left, the analysis is greatly simplified.  Trading strategies are fairly obvious.  I re-plot the data in Chart 1, but now expand the scale from -40 to 120 for both axes to give us some room to doodle.  First, the vast majority of stocks are in a neutral zone from 20:80 on both axes.  These are stocks we can ignore, or start tracking only if they approach the edges of the yellow box.  The strongest stocks are in the green box at the upper right (SCTR > 80, CTM > 80).  Trend-following, long-only strategies are favored in this zone. The zone in the red box features weak stocks.  Here short-side trend-following strategies make sense.  Alternately, counter-trend or value strategies might also make sense in the red zone.

Chart 2:  Trading strategies can be organized by trend strength i.e., for strongest stocks or weakest stocks.  Stocks in the neutral are candidates for buy-and-hold approaches.


Cramers Symbols Week of 06/11/18

I have plotted a few of Cramer's symbols from this week without regard to market capitalization, i.e. the comparison universe for SCTR ranks.  Many of his picks are in the green box from Chart 2 (SCTR > 80, CTM > 80).  So he has focused on strong stocks.  A few are at the edge of the neutral zone (20:80) but are close enough to the edge to merit further analysis.  Only a few are firmly in the neutral zone.  So, at a minimum, strong stocks were favored this week.  Remember that new data can rapidly change the market's assessment of the prospects for any stock, so it is likely (but not guaranteed) that strong stocks will remain strong.  In other words, a long-term trend-following approach, that does not use profit targets is the appropriate strategy, which recognizes that a stock is strong until it isn't and trades accordingly.

Chart 3: Cramer's pick this week were generally among the strongest stocks in the market as a whole. 


Ranking versus the Average Stock

We can re-do Chart 3 to plot the difference in SCTR and CTM versus the average SCTR and CTM values for the S&P 500 stock universe. So we can re-do the calculations so that the average stock in the S&P 500 is a the center of the plot (i.e., at 0,0).  So, stocks in the upper right-hand quadrant will be much stronger than average.  Cramer's picks this week were much stronger than average.  The market is telling us which stocks it favors by showing us which ones are performing much better than average (in the upper right hand quadrant).  Since the market's assessment of the prospects of a stock (or simply, trader's willingness to hold them) can change quite rapidly, a trend-following strategy with a reasonable trailing stop can capture a good chunk of the potential gains without having to pinpoint the exact high or low (though not without patience and strong nerves).

Chart 4: We can re-plot Chart 3 to emphasize the relative and absolute strength versus the average stock.  Intermediate- to long-term trend-following strategies can be implemented with reasonable stops in the upper right-hand quadrant.


The Big Picture

The media as a whole and the blogs everywhere are full of stocks highlighted for one reason or another.  The plots discussed here are a way to put those symbols into a perspective that suggests logical trading strategies.


Tushar Chande
About the author: , PhD, MBA, is the inventor behind an impressive collection of technical indicators, including the Aroon and Stochastic RSI. He has written several books, holds both a PhD in Engineering and an MBA in Finance, and has over two decades of experience trading the financial markets. Follow Tushar in this blog as he highlights his new "Trend Meter" indicator and shares his analysis of current market conditions. Learn More
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