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IBD’s 20 Rules for Success

May 17, 2007 by 7 Comments

IBD, otherwise know as Investor’s Business Daily, has compiled a basic set of rules for success. They claim that your investment results should improve materially if you carefully follow these 20 rules (rules in bold lettering).

I have added my “two cents” after each rule based on my experiences as a trader. I can tell you that these rules helped establish my foundation towards successful investing.

New readers can try the paper for free for two or four weeks depending on a print or electronic version: Free Trial

I now use the eIBD electronic version so I can save them but I started with the print version (both are great for their own reasons).

1. Consider buying stocks with each of the last three years’ earnings up 25%+, return on equity of 17%+ and recent earnings and sales accelerating.
CP: This is an excellent rule to follow as it will filter most of the poorer performing stocks from your initial screens. Many of my fundamental screens contain these parameters although I do eliminate or loosen the ROE parameters at times.

2. Recent quarterly earnings and sales should be up 25% or more.
CP: Love this rule as earnings results do have a direct relationship to share price

3. Avoid cheap stocks. Buy higher quality stocks selling $15 a share and higher.
CP: I follow this rule about 95% of the time. It’s a must for novice investors as much of the market’s garbage is priced below $15 per share. However, I will occasionally trade a stock below $15 per share if the risk-to-reward ratio warrants the position.

4. Learn how to use charts to see sound bases and exact buy points.
CP: Learning technical analysis is a must to become a successful trader. Thousands of methods exist so discover the few that fit your trading style. Read through this blog to become familiar with my technical methods.

5. Cut every loss when it’s 8% below your cost. Make no exceptions so you can always avoid huge, damaging losses. Never average down in price.
CP: First – NEVER average down in price, NEVER! Second, always cut your losers based on your position sizing calculation which should have a direct relationship to your risk-to-reward setup. Don’t allow losses to grow larger than 8-10%.

6. Follow selling rules on when to sell and take profit on the way up.
CP: Always sell when a rule is violated. Examples could be a price falling back below a specific moving average, a specific retracement from new highs or a trailing stop.

7. Buy when market indexes are in an uptrend. Reduce investments and raise cash when general market indexes show five or more days of volume distribution.
CP: Follow the trend! Whether it is up or down, trade accordingly!

8. Read IBD’s Investor’s Corner and Big Picture columns to learn how to recognize important tops and bottoms in market indexes.
CP: I do recommend these sections of the newspaper but you can also formulate your own methods for signaling market tops and bottoms (I like to monitor the NH-NL ratio and my own index of 20-30 of the market’s leading stocks).

9. Buy stocks with a Composite Rating of 90 or more and a Relative Price Strength Rating of 85 or higher in the IBD SmartSelect® Corporate Ratings.
CP: This is a great rule for strong bull markets but the parameters must be loosened in flat or weak markets. I set my fundamental screeners to a minimum rating of 70 for both EPS and RS. I rarely use the smart select ratings from IBD.

10. Pick companies with management ownership of stock.
CP: I don’t care about this rule and don’t follow it in my research. It can help but I have never based a trading decision off of this rule.

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Filed Under: Education

How to Short a Stock

May 14, 2007 by 14 Comments

To short means that you borrow stock from your broker to sell to a third party. The idea is to buy back the stock at a lower price, returning the shares to your broker while leaving the remaining cash in your account as a profit. A short seller does not own the stock before they sell it as they borrow it from another investor who already owns it. At a later date, the short seller buys back the stock they shorted and returns the stock to close out the loan. If the stock has fallen in price since they sold short, they can buy the stock back for less than they received for selling it. The difference is your profit. Please note that short selling is a transaction made on margin.

To initiate a short sale, you must place the order with your broker or online brokerage by determining the size and price at which the trade will occur. Your broker or brokerage company will check to see if shares are available in the specific stock selected or if they can borrow the shares. Once they are available or can be borrowed, they will be sold in the open market on the first plus tick or continuation of an up-tick also known as zero-plus tick (the stock must move up for the transaction to complete). To close the short position, the broker will purchase the shares using the original proceeds and return the shares to the third party.

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As a short seller, you believe that the price of a particular stock will fall in value over time. For example: by establishing a short position for 100 shares in XYZ at $50, the broker will place $5,000 into your margin account. If the stock falls over the next few weeks and you decide to cover the short at $40, you will initiate a buy for 100 shares in XYZ using the money placed in your account when you sold short. The cost to buy back the shares in this example will be $4,000 or $1,000 less than the original short sale amount. This difference in price will result in $1000 cash that will now become your profit.

On the flip side, if the stock was to jump to $60, you would most likely cover your short or have your stop loss triggered, buying back the shares at this price. The cost would be $6000 or $1000 more than the original short sale, resulting in a 20% loss. The broker would take the additional $1000 from your cash account to cover the loss in the short sale. This is how you can lose money when shorting stocks. The higher the stocks rises, the more money you can lose, theoretically resulting with an infinite loss (excluding stop losses and broker margin calls).

If the stock rises in price or if the value of the stocks you are using as collateral goes down in price, you may be forced to add cash to your margin account or cover the short sale prematurely. Keep in mind that you must pay any dividends issued while you are short a particular stock.

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Filed Under: Education, Shorting

How to Create a Successful Stock Watch List

April 5, 2007 by 19 Comments

Follow these steps and you can create a powerful stock watch list in the matter of minutes to an hour each night. I work longer than that but it can be done in less time if need be. This watch list will generate opportunities for trend buying, swing trading and even shorter-term trading. I guess the occasional buy and hold investor could even benefit from this very simple procedure if they purchase at the right time.

I encourage all investors in all time frames to evaluate stocks for investment using both fundamental and technical analysis. A day trader and even a swing trader can get away with avoiding fundamental analysis but I highly recommend both methods of analysis for intermediate and longer term trend traders. Both tools are equally important in making serious decisions with your hard earned CASH!

If you wish to invest in stocks, treat it like a business, NOT A HOBBY. You need rules and you need to follow these rules or money WILL be LOST. Once proven rules have been established, they cannot be broke or you will lose money. Everyone loses money in investing but we must learn to cut losses quick and allow gains to develop. Small losses are acceptable because they teach us lessons that allow us to win big. Think of losses as part of doing business and focus on the long term success of the system and not each individual trade. As long as you have a positive expectancy, the winners and losers will equal out over time to make you consistently profitable.

Now to the watch list method:

  • Determine if overall market is in a specific trend (up, down or sideways).
  • Use a computerized screener to find stocks with superior fundamentals
  • Evaluate sister stocks or stocks within the same industry group (strength travels in groups so the probability of success rises when buying into a strong industry).
  • Study the technical aspects of the charts for each possible opportunity

Simple Fundamental Screener Criteria:
The criteria listed in this section can be used together or arranged in a variety of ways to generate multiple lists containing all possible opportunities. Get a feel for specific screens and determine which are the most successful during certain market conditions.

  • Increasing Earnings (current, past: quarterly, yearly and future estimates)
  • Increasing Sales (current, past: quarterly, yearly and future estimates)
  • Stocks making New Highs
  • Stocks within 15% of New Highs
  • Stocks within 10% of the 200-day moving average
  • Increasing Return on Equity (ROE)
  • Price/Earnings Growth (PEG) – Less than 1 is preferable
  • Accumulation/Distribution ratio
  • Up/Down Volume over past several months
  • Increasing Institutional Sponsorship

Simple Technical Analysis Scans (with your own eyes):

  • Study the one year weekly chart (preferably candlesticks)
  • Study the six month daily chart (preferably candlesticks)
  • Look for increasing accumulation days (stock up on above average volume)
  • Evaluate the Point & Figure chart for support and resistance levels
  • Look for basic chart patterns such as flat bases, cup bases, saucer bases, triangle breakouts, obvious trends along a moving average, etc…

That is all one needs to develop a quality list of opportunities night in and night out. Trading opportunities will appear once you see a particular stock make multiple screens on a consistent basis. This is the basic foundation I use to pinpoint my opportunities in the market and the general guidelines I used while running MSW.

I use the custom screen wizard from Daily Graphs (Investor’s Business Daily sister company) for my fundamental analysis because I love young growth stocks but many tools exist on the web. Some are free and some cost a pretty penny to use. My screener costs $45 per month which is nothing to me but maybe too much for others.

Please leave a comment on what screener you use and why. Leave a link to the screener that you use to give the site or business credit. I am very curious to hear what other trader use. As great as the wizard is for me, I am always looking to find something better.

Filed Under: Education, Fundamental Analysis, General Market, Stock Screens

Industry Analysis Using Investor’s Business Daily

March 20, 2007 by Leave a Comment

Using industry analysis can play a very important role when looking for quality stocks to place into your portfolio or looking for laggards to sell. As we know, sister stocks travel in groups and 50% to 75% of a stock’s move can be attributed to the industry group itself. Therefore, it is a smart idea to study which groups are the strongest and which groups are falling out of favor.

Looking below, we can see that several Oil & Gas related industry groups are topping the charts along with metal related groups over the past week. They are the groups making the strongest advances over the past five trading days according to the data from IBD. I do gather the majority of my data from the electronic version of Investor’s Business Daily and have been a member since 2001.

When viewing the strongest one week and year-to-date moves, we can see that growth stocks are not leading the market as industrial related industries are making the best gains. Oil, metals, machinery, energy and trucks are populating my screens which tell me that the market is in defensive mode, not offensive and that is why much of my account is in cash (among other reasons).

Top 10 One Week Industry Moves:
Diversified Operations
Metal Ores – Gold/Silver
Oil & Gas – Field Servic
Oil & Gas – US Expl Pro
Utility – Electric Power
Metal Prds – Fasteners
Comml Svcs – Printing
Tobacco
Food – Misc Preparation
Oil & Gas – Drilling

Top 10 Year-to-Date (YTD) Industry Moves:
Oil & Gas – Machinery
Energy – Other
Auto/Truck – Original Eqp
Machinery – Farm
Oil & Gas – US Integrat
Machinery – Constr/Mining
Trucks & Parts – Hvy D
Comml Svcs – Schools
Machinery – Tools & Re
Elec – Parts Distributors

It is also important to follow the weaker industries so you can determine the overall market trends and trade according to the stocks in favor. Several hi-tech growth industries have fallen to the bottom of the pile over the past week and for the year. Multiple computer and internet related industries are leading the market to weakness as retail and finance are not far behind. Of course I can’t forget to mention that the residential building industry has lost its recent steam but seems to be gaining some support near multi-year lows. This could be a buying opportunity area for longer term value investors if support holds.

Bottom 10 One Week Industry Moves:
Bldg – Resident/Comml
Soap & Clng Preparat
Retail – Consumer Elec
Internet – Content
Retail/Whlsle – Jewelry
Retail – Leisure Products
Finance – Investment Bkrs
Telecom – Equipment
Leisure – Hotels & Mot
Bldg – A/C & Heating

Bottom 10 Year-to-Date (YTD) Industry Moves:
Computer – Peripheral Eqp
Computer Sftwr – Desktop
Finance – Investment Mgmt
Retail/Whlsle – Cmptr/Cell
Bldg – Resident/Comml
Finance – Investment Bkrs
Retail – Consumer Elec
Retail – Leisure Products
Medical – Ethical Drugs
Computer-Manufacturers

Filed Under: Education, General Market, Sectors & Industries

Paper Trading: Nothing to Lose, Nothing to Learn

March 19, 2007 by 7 Comments

With nothing on the line, emotions fall to the wayside and you will probably miss the opportunity to learn something about yourself. Trading in the market is essentially learning about yourself and how you react to positive and negative situations. A great speculator once said that the market is an expensive place to find out who you are. However, you will never find out who you are by trading a paper account or virtual portfolio.

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Paper trading seems to be the most over emphasized technique offered by market theorists, educational elite, market novices and/or market frauds. While learning the pure basics, I can see why a novice investor may want to paper trade; to see the results of the developing system but I will warn that these results are completely false. The results will not contain the emotional decisions that go along with risking your own cash. Anyone and I mean anyone can paper trade successfully.

It’s simple: place a trade and hope it goes up and if it doesn’t, you have no worries because you can’t lose. Therefore, you are apt to forget about sell stops, position sizing, risk-to-reward ratios and you will never experience the pressures of an up and down market when your position shows a profit or loss. The emotional imbalance that occurs when you really start to lose money is not present. Don’t fool yourself by believing the results of your paper trading or virtual portfolio. These things may give you some confidence in your system but they don’t prove a damn thing in the real world. The real world, specifically the stock market, is run by emotional human beings. People make decisions that are irrational and base their trading decisions on fear and greed. Paper trading lacks fear and greed because there is no gain and no loss; therefore there is no consequence to deal with.

We should all know by now that emotions are tied to our decisions in the markets so we can only get accurate results through actual trading. Learn to ignore the talking heads on TV that claim they are up over 1000% trading a fake account. What really makes me laugh is the person that sets up a virtual trading scenario and then allows each participant to trade $500,000 or more in their account. If you are going to trade a fake account, at least keep it authentic so you can try to learn something within the scope of reality; potentially money management.

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I setup one virtual trading competition a few years back and I only allowed each participant to start with $10,000, a reasonable amount, an amount that most people start trading with. Traders are undercapitalized with $10,000 but most people start trading with this amount. The competition was fun but it was not real for me or the others. I didn’t care what risks I took and I never had a problem pulling the trigger which does happen in real life. I did try to keep my trades in line with my real life account but it varied slightly. I witnessed other traders making 20 trades per day or 20-50 trades per week. This is not real because the commissions alone, even with a discount broker will wipe you out (we weren’t day trading in this competition). I did allow margin but I saw investors abusing the fake power of leverage in their virtual account, again, playing the game for fun instead of learning something valuable.

Professors and the like teach theories while investors actually do the trading! Why would I waste my time playing for fake money when I can learn and do for real? If you want to test a system, open an account with real money, even a minimal amount and give it a try. Make sure you use enough money to allow emotions to be attached to your decisions. Without the emotional attachment, you are cheating yourself and your potential results.

This article was originally written by me back in 2005 under a title: Trade for Real

I updated the article to my current beliefs and renamed it after some excellent advice from Copyblogger during a recent exercise: Headline Remix Madness – Part Two

Filed Under: Education, General Market, Psychology
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