Amongst investors these days, there are a number of lively debates going on. Fundamental analysis versus technical analysis, the role of behavioral finance, or where the best investment ideas come from. Pulling no punches here, I maintain that in today’s modern stock market, you are either part of the Charting Age or you are in the Stone Age. The divergence of investor opinions on these subjects is not unlike similar debates in other fields.
In the scientific community, a significant number of pivotal ideas have historically come from “outsiders” who are not bound by the inbred conventions of a specific scientific discipline. In business school, I was taught to look for breakthrough ideas by surveying customers, interviewing market players and analyzing competitors’ strategies. On other fronts, various authors have written about the need to find your own individually stimulating space in which to ferment your own thoughts and thereby breed ideas either by the “slow hunch” approach or via the “aha moment” approach. Some have even suggested the bathtub or a fishing boat as creative options!
As a trader, I’ve found all of these woefully inappropriate. Revisiting my trading journal to find my most profitable trades, I realize that my best ideas have not resulted from some creative incubated hunch. Invariably, they have been the result of specific step-by-step disciplined investigation. My objective has not been to come up with unique undiscovered investment opportunities in the stock market. Generating new ideas like that yields a low probability trade for an individual investor. Instead, my objective has been to uncover what creative institutional investors deem as their most investable opportunities.
In this regard, being a detective has been far more profitable for me than trying to be a creative predictor of the future. Herein lies my “aha moment”. My main focus has simply been to design a disciplined approach to uncover and reveal the equivalent of the market’s sweet spots. I leave the big ideas to the big institutional investors with the big money. As an individual investor, I have found there is a higher probability of realizing profits by focusing on what is happening in markets instead of trying to ascertain why it’s happening or what’s about to be the next hot thing.
The American Association of Individual Investors (AAII) asked its members to disclose the primary sources of their stock investment ideas. The top two most popular answers were newsletters and recommendations on financial websites. For a whole host of reasons, I was shocked by these results. I decided to poll the 100 students in my investment class using the same survey. The results were similar. Financial websites generated the most ideas, followed by computerized screens and search scans a distant second.
Relative to these two surveys, I’m an outlier. My approach is straightforward. If it looks like the market, feels like the market and behaves like the market, then that is exactly where I want to focus my detective skills. I apply my visual and technical filters in four phases. Phase One is to apply my “Permission to Buy” filters to the broad market indexes. If I get a green light there, I then go on to Phase Two to ascertain which of the S&P sectors is outperforming the market. Phase Three is to focus on the top industries that comprise the leading sector. Once I have identified the top two industries, I dig into Phase Four to identify the individual stocks that are the leaders within those industries. These are the equities that institutional money managers have identified as “great ideas” and where they are committing their investable dollars now!
There’s no slight of hand or creative genius in this approach. It’s analogous to a great movie stunt team – preparation is everything. I think of myself as a “ visual stock market filtering ninja”. Having reviewed literally millions of charts in my trading career, I can visually wade through these high probability charts very quickly to tell which ones are becoming the darlings of the institutions and how those institutions are voting with their dollars. My winning trades are the product of this very sort of disciplined step-by-step visual investigation.
I leave the next new thing to the big institutions. But as soon as they express their financial interest, I’m right there to keep them company by investing alongside them in their targeted industry and their favorite group of individual equities. My ego finds it more rewarding to play the discovery side of the equation versus the big bold self-generated idea side of the market.
On which side of the equation do you see yourself? I suggest that individual investors spend less time looking to others to generate investable ideas and instead devise their own system to piggyback upon the ideas and money flow of the big institutions. My trading journal bears witness to the fact that this stock market detective has done exactly that and trumped the idea generators a majority of the time.
Trade well; trade with discipline!
-- Gatis Roze
Presenter of the Tensile Trading DVD, Stock Market Mastery.
Developer of the StockCharts.com Tensile Trading ChartPack.
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