We chartists are a dedicated lot, but at the risk of alienating my fellow technicians, we are sometimes too myopically focused just on charts at the expense of profits and have been known to succumb to something I'll label "The Shiny Chart Syndrome". This blog is called The Traders Journal for a reason. For ten years now, I've tried to be brutally honest and candid, so please hold your aggressive rebuttals. Here are my conclusions from trading the markets for over thirty years as a "rational investor" or my updated label "technomodernist", one who combines technicals and charts with fundamentals and modern media.
William O'Neil was spot on when he developed the CAN SLIM investment strategy for growth stocks and made "Institutional Sponsorship" one of the seven essential legs of his acronym. His pioneering work is based on studies of winning stocks dating back to 1953. It's clearly stood up to the test of time, as well as testing by the American Association of Individual Investors (AAII) which has rigorously monitored over 60 different investing strategies for decades now. O'Neil's methodology has been consistently at the "top of the charts" to use a music analogy. Grayson and I freely admit that our methodology which goes by the name of "BATTLE V" – detailed in our book, Tensile Trading — is an enhanced derivation of O'Neil's methodology.
Too often we technicians place stocks on our watchlists based on complex scans we've written — breakouts to new price highs, increasing momentum, increasing relative strength versus the market, the sector, the industry group — so on and so forth. As Jesse Livermore often said, it was his sitting that made him the most money — not his trading. If we want to find stocks with staying power to invest in and sit on as Livermore says, we best have Institutional Sponsorship. If we are to put investment probabilities at our backs, the big money guys better have discovered the equity and already started to accumulate their positions.
If you think you've uncovered the next Amazon and its institutional sponsorship is minimal, I've found it's often akin to a bait-and-switch game where the emotionally driven price run-up is not sustainable. My experience has been that stocks with significant institutional endorsement allows me to sit and profit from a positive trend.
Therein lies the key difference between an investment versus a trade. Cardinal Rule: don't ever get the two confused. If it's a stock you decide to trade, stay true. Keep the stops tight and the sell finger on the trigger. Once you've allowed a stock trade to be relabeled as one that's now an ‘investment', your positive probabilities cease working for you. You've lost your edge.
In a recent interview with Kiplinger Magazine, Jack Brennan, the former CEO of the Vanguard Group said, "The idea that trading is the way you invest your serious money is misguided".
Back to the need for institutions to show some love for a stock. O'Neil's paradigm emphasized technicals such as relative strength and market direction, but equal emphasis was also placed on supply and demand as well as Institutional Sponsorship. Money flow indicators, such as On Balance Volume, do gauge these latter two but I'd like to suggest you dig deeper.
For example, in our ChartPack we monitor a list of six exceptional stock pickers (i.e. mutual funds) that have clobbered and out-performed the S&P 500 over many different time periods (for example, 10 years S&P 500 = 15.1% per year versus Mutual Fund = 24.0% per year). You get the idea. Using the X-Ray function in Morningstar, it's easy to unbundle their holdings and review the stocks they are buying. There are other tools available with your brokerage houses which yield the same insights. This is precisely how I got into Amazon, Visa and Mastercard over a decade ago, and I've been "sitting" ever since.
There's a list of other stocks (too painful to list) that I jumped into prematurely before accumulation and institutional sponsorship was evident, based on my "unique insights" while invisiblizing essential fundamentals which led to trading that resulted in little or no profits. Amazon is a good example, Twelve years ago there wasn't the wide institutional sponsorship even though there was some sponsorship building at the time. That expanding sponsorship was the foundation of its price appreciation and increased the probabilities of a profitable investment. Note that I didn't say "trade". But "sitting" does work.
Back to the watchlists. Say we have ten stocks in our watchlist, all generated by attractive technicals. How do we rank these options? I've already outlined the sponsorship requirements. Let's touch on earnings and earnings growth. The "C" and the "A" in O'Neil's acronym.
I prefer graphs that plot a stock's quarterly revenues and earnings so I can see trends. I also like charts that show actual earnings versus analysts' consensus EPS to see those trends and also determine if the company historically beats (exceeds) expectations or whether it misses projected earnings.
In addition, I acknowledge that analysts do impact the behavior of institutional buying. Therefore, I track their ratings, their price targets for the stock and whether they're upgrading or downgrading their assessments. All your brokerages online have variations of this information. Yahoo Finance also colorfully charts this data and is available for no cost.
Finally, another tool you might consider in ranking your watchlist stocks is using one of the available "Graders". Louis Navellier has his "Portfolio Grader", and Zack's has its "Ranking" rating. Fidelity will give you a cumulative 'Equity Summary Score' based on the top 10 analysts following each equity. There are many more, but make sure that their methodology aligns with yours. Navellier's orientation is growth stocks which does mesh with my own. Personally, I'm not interested in other ‘graders' (which will go unnamed) that are oriented around value stocks. So there you have it!
Generate your watchlist as a chartist / technical analyst, but then caveated by the use of these fundamentals to rank your options. The challenge is to limit the number of options in your watchlist to match your personal bandwidth — whatever that might be. I suggest that you review these three spheres:
- Institutional Sponsorship and Money Flow
- Earnings, Revenues and Analysts Projections
- Stock Graders
Remember that your role in this quest is that of "Reality Czar" and that's best achieved by combining your charts with fundamentals.
With this review, the cream in your watchlist will magically rise to the top and your probabilities for profits will rise as well.
Trade well; trade with discipline!
- Gatis Roze, MBA, CMT
- Author, "Tensile Trading: The 10 Essential Stages of Stock Market Mastery" (Wiley, 2016)
- Presenter of the best-selling "Tensile Trading" DVD seminar
- Presenter of the "How to Master Your Asset Allocation Profile DVD" seminar
- Developer of the Tensile Trading ChartPack for StockCharts members