Articles from Feb 2007

How to find high probability shorts

If you want to find shorts with 5%-20 opportunities, there are many ways to do it. Those are normal pullbacks in most stocks. But if you want to find long duration plus more profitable 30% plus kind of shorts, the task is slightly more complicated.

The reasons are obvious. Unless you are genetically predisposed to bearish strategies a simple study of worldwide market tells you that there is a steady upward drift in the markets. That is why passive investment and Index based long strategies work so well. So structurally one must accept lower profit on short ideas. The other problem is you will find very few smooth waterfall moves down. While you will find many smooth multi year up moves on stocks.

So given all those constrains in my scheme of things short is a low priority trading opportunity. Unless there are no compelling longs I don't look at shorts. However I have spent significant time and effort developing some profitable short strategies. Because under certain circumstances they offer good opportunities.

The central concept behind most of my short ideas is based on the post I made some time ago - Earnings expectations and Cinderella Strategy. Essentially you must find a earning torpedo. If you find it on high growth stocks, which has been bid up a lot and is the darling of big funds, you get one smooth ride short. Such things are rare but highly profitable. Catalyst is extremely critical on short side, otherwise usual corrections are quickly bought. A mere miss on earnings may not be best short strategy. What works is if you have a sequence of earnings like say 30, 34, 45, 50, 44, 69, 40, 34. 69 , and then 7 or -20, then there is virtual scramble to get out. Because before the torpedo the stock was favorite of all growth funds

Now how does one find such stocks. One way is to follow the earnings. But there are other problems associated with shorting and that is availability. So after a considerable research and practical experience as a choice I have decided not to look at such stocks on below a certain float thresh hold. Stocks with low floats can make good shorts, but I seldom get a supply of them. So most of the time by choice I concentrate my shorting efforts on 100 million plus float stock.

Now regular readers of this blog know, I am always looking for some short cut to find such stocks. So I have found some pre existing lists which offer you good short candidates. So here are some concepts which will get you high probability shorts:
  1. IBD Mutual Fund list: On Page A9 everyday IBD publishes two lists. Largest Positions of funds in Big Cap Index and Largest positions of funds in Value Index. This list changes very slowly. Essentially a fuck up on any one of the stock in the Growth Fund list is great short. Similarly any new addition/subtraction is worth paying attention to. There are only 20 stocks in the list daily. ( This list is also useful for long ideas)
  2. Trouble after Double: This is all those stocks which have 100% or more growth in last 2 years and float above 100 million and during the move crossed price of 40. On this list I look for 4% down moves for entry. ( All stocks which during last 540 days period doubled from their 260 days low and have a float of 100 million and were priced 40 plus. Don't ask me how to do it in TC2000. You can not do it in that programme.)
  3. Episodic Pivots: Here you are again primarily looking for earnings miss or regulatory trouble.
  4. Now besides this earlier I have used another ready made list which uses a slightly more advanced concept of torpedo strategy and offers some very good opportunities- Earnings Torpedo Warning list. This list is maintained by Ross School of Business @ the University of Michigan.

As usual do your own research before trying any of these. The key is to understand the basic concept.

Next: How I make money reading a newspaper in microscopic detail
James Crammer says Watch TV get Rich. I have found a better way...........

Paternity fight over big crash

The big crash is not a bastard. There are several claiming that they predicted it. I went through my over 500 Google Readers feeds and the usual suspects plus every Tom Dick and Harry is claiming they predicted it.Some have been predicting this for their entire life. Some who were saying Greenspan call was contrary indicator to buy have quickly changed their tune to claim paternity of this crash.

The real issue is markets are not controllable. But your reaction to them is. Your trading methods are completely under your control. Market is what it is. How I react to it is important. For any given time period there is a pool of potential profit available to all market participants. Some have better method of grabbing part of that pool, some have no methods.

Now that the event has happened the big question is what is the game plan. If you think opportunities are on short side or on long side you still need a method to extract that money out of market.

As I have said before in my scheme of things conceptually I look at my trade factory having many conveyor belts. The conveyor belts bring opportunities to me, I inspect and put on trade based on risk and return parameters. Now in this trade factory there is one area for bullish conveyor belts and one for bearish. For several month the well oiled bearish conveyor belts were more or less not bringing much of opportunities. Yesterday the bearish trade factory got humming. So now bearish opportunities will present themselves.

As a speculator all I am interested in is where is the next big opportunity. If it is on bearish side I have well oiled strategies to capitalise from them. Like my long ideas all my short ideas are based on some fundamental structural concepts. Those ideas work best in bearish environment.

So there is no point in getting involved in to all the discusion of who called it right or wrong, what matters is how much you profit from the opportunity the market presents.

Double Trouble

All rallies come to an end. Sometime they end dramatically, like we saw today. From July the market was in rally mode with little pullbacks or correction , so a correction is not a bad thing. If you have made money in last 8 months, the trick is to not give up much of your profit.

Now the next game plan is more important. Again the question is what will maximise profit for a given time frame. To short also you need to find right stocks to short. The stocks likely to go down the most are best shorts. Finding them is much difficult task than finding longs. Because things do not work the same way on short side. Anyone who tells you to do reverse of what you do for long for short has no idea of what he or she is talking about.

So if this correction has legs on downside, you will have opportunities to find low risk high probability opportunities. First and fundamental thing is capital protection. For long term traders better opportunities will show up in few days.

Market Monitor

Total 4% plus bullish breakouts=24
Total 4% plus bearish breakouts=1404
65 day bullish/bearish ratio= 656/281
Stocks up 50% or more in a month=8
Stocks up 25% or more in a month=65
Number of stocks with 100% plus move =294
Number of stocks up 200% or more = 69
4% plus signals for 100plus universe=2
4% plus signals for 200plus universe=1

Select stocks which had 100% plus move in last 260 days from the low and which are up more than 4% on higher volume. Today's minimum volume is above 100000. To understand how to trade this see my earlier post "How to find a stock which makes 1500% move in a year"

SGN,Signalife Inc (Google  Yahoo  Earnings  Chart
TATTF,Tat Technol Ltd (Google  Yahoo  Earnings  Chart

Now in the midst of this carnage Radioshack managed to make a 12% move. What was the catalyst- earnings announcement. In January it had a high volume day after raising earnings guidance , since then it has gone up about 50%.

Keep a close watch on companies announcing earnings acceleration even during this sell off. That will convince you of the power of earnings as a catalyst.

Market Panics and Niederhoffer

It is easy to lose perspective on days like today. But panics are good for markets. The most important thing to look at is what happens after the panic. Like a rubber ball the markets bounces back.

Victor Niederhoffer often quotes Henry Clews when it comes to market panic:

Henry Clews wrote in Twenty-Eight Years in Wall Street (1887):
But few gain sufficient experience in Wall Street to command success until they reach that period of life in which they have one foot in the grave. When this time comes, these old veterans of the Street usually spend long intervals of repose at their comfortable homes, and in times of panic, which recur sometimes oftener than once a year, these old fellows will be seen in Wall Street, hobbling down on their canes to their brokers’ offices.

Then they always buy good stocks to the extent of their bank balances, which they have been permitted to accumulate for just such an emergency. The panic usually rages until enough of these cash purchases of stock is made to afford a big “rake in.” When the panic has spent its force, these old fellows, who have been resting judiciously on their oars in expectation of the inevitable event, which usually returns with the regularity of the seasons, quickly realize, deposit their profits with their bankers, or the overplus thereof, after purchasing more real estate that is on the up grade, for permanent investment, and retire for another season to the quietude of their splendid homes and the bosoms of their happy families.

Few more days like today and we will be at ideal bounce scenario. So keeping the powder dry is the key.

Readers Questions

In recent days and weeks there has been a flood of new visitors, thanks to the following folks, who have linked to various posts.

There are lots of mails I am going through currently and answered most of it. If your question is still not answered you should hear by the end of the day.
Here is a quick and dirty summary of most of the things I have said in the individual mails about various issues.

Long Strategies:
All things I trade and write about revolves around three basic concepts. Earnings, momentum and neglect. Various strategies are just different versions of same ideas. It is like Coke, Classic Coke, Diet Coke, Vanilla Coke , XXX Coke, etc. versions of same basic strategies.
So if you want to trade them you need a good and deep understanding of those three concepts.
My trading time frames are medium to long durations with most trades lasting weeks to months.

Holy Grail: There is no holy grail. I am not selling any service, no software, no mentoring service and no black boxes. None of this is magical stuff. It will take at least 6 months for anyone to understand and duplicate the strategies.Lot depends on market circumstances, some things do not work under some circumstances. That does not mean the strategy is wrong.

Trading set up: I am surprised by number of questions on this. All I have is two old computers and one laptop. I use Worden brothers TC2000 for data. I also have Amibroker, which I rarely use. From TC2000 software I pull data in to my own data analysis and trading system development software and bulk of my systems operate on it.
I use Interactive Brokers.

All scans I have mentioned so far are in TC2000. When trying to use them in other programmes be careful of volume parameters because TC uses different volume parameters.

I do not disclose my returns, but I am profitable for last 6 years and have outperformed market by large margins. How much you will make out of these strategies depends on how you execute them, how much you understand them and above all what kind of risk management strategies you use. I get high returns because I classify my ideas as A, B, C, class ideas and risk different amounts on different ideas (A-10%, B-up to 5% and C1%). Also I vary my risk based on market phases. I also vary my risk based on how much I am up for a year. If early in the year I have high returns then I risk more on some ideas in subsequent months. That can make significant difference to your returns.

Lot of you have asked for recommended books. I will by the end of this week put together a list of 5 to 10 books or resources which might be helpful.

Weakness is good

Looks like we are gapping down. Now the action like what you see today is coming after a long and enduring rally. So it is not a bad thing. Now the usual perma bears will be dancing in the street saying we told you so. But if you want to make money, you should not be very worried. And also if you want to make money in a market with 100 years of updrift, you should any way never follow perma bears.

Most sell offs have an intense selling phase. This last few days or few weeks. The risk is highest during such periods on existing positions depending on where your entry was. The moment the intense phase gets over, slowly you will find the 100% list blossoming again. In fact you will find very good set ups after few days of weakness.

On an individual stock if there is a catalyst, barring the intense sell off phase, you would find it will still rally. The universe narrows and you might need larger stops but there are opportunities.

On the short side you will find good opportunities in the same 100% plus universe once the market turns. Later I will talk about how using the same concept of 100% plus moves in 260 days you can build a short system. It works best when market reverses after a long rally.

Later: How to find high probability shorts

Just buy the dips

The market character has undergone a change in last few days. It is a slow process and many new themes are emerging. Some old themes have for the time being run their course. In a rally of long duration, such correction zones are a bit tricky because if you remain on sideline the new emerging sector rallies you will miss out. If you short at this stage you will need good heart to hold through some nice volatility.

Some things are clearly visible. The large caps are no more the favorite. Some sectors like financials, brokers, airlines, etc. have entered correction zones after strong rallies. The small caps are back in action. More than that several new sectors are emerging as likely to take on leadership. The health care/biotech sector continues to find buy interest. But again the kind of companies leading in the sector are not the ones people are most familiar with. The Internet related sector is also attracting buying. Similarly some software companies are also in recent up trends. The commodity sector and alternative energy sector has seen the largest number of breakouts in recent 20 days. The most attractive sector currently is funeral services!!!!

CSV a funeral services company with episodic pivots

While the sector action is interesting, it is individual stocks where most of the action is for individual traders. Upside breakouts continue to exceed downside breakouts and for almost 10-15 days the breakouts above 4% have been 100 plus. So this still looks like sector rotation and churning.

In few weeks the markets attention will shift to next earnings and some stocks will start breaking out in anticipation. One thing to watch closely is analysts future earnings estimates revisions. The ratio is moving up currently for 2007.

Double Trouble

The Index weakness today was deceptive. For the first time in this rally the 100% plus universe has crossed 400 today. As I have said earlier, this number can go up to 1200 plus in healthy rally and the 200% plus number exceeds 300 by the end of rallies.
If you look at number of breakouts in the universe , it has increased sharply to 36 indicating buyers still at work. So far the market action looks like garden variety sector rotation and post earning season selling in some sectors.

Market Monitor

Total 4% plus bullish breakouts=109
Total 4% plus bearish breakouts= 66
65 day bullish/bearish ratio= 957/193
Stocks up 50% or more in a month=13
Stocks up 25% or more in a month=139
Number of stocks with 100% plus move =402
Number of stocks up 200% or more = 90
4% plus signals for 100plus universe=36
4% plus signals for 200plus universe=6

Select stocks which had 100% plus move in last 260 days from the low and which are up more than 4% on higher volume. Today's minimum volume is above 100000. To understand how to trade this see my earlier post "How to find a stock which makes 1500% move in a year"

Select breakouts from the list:

EVOL,Evolving Systems Inc (Google  Yahoo  Earnings  Chart
FTEK,Fuel Tech Inc (Google  Yahoo  Earnings  Chart
INCY,Incyte Corp (Google  Yahoo  Earnings  Chart
MFRI,Mfri Inc (Google  Yahoo  Earnings  Chart
OMRI,Omrix Biopharmaceuticals Inc (Google  Yahoo  Earnings  Chart
RIMM,Research In Motion Ltd (Google  Yahoo  Earnings  Chart
SONS,Sonus Networks Inc (Google  Yahoo  Earnings  Chart

OMRI almost trippled from its first episodic pivot. The second major episodic pivot on earnings annuncement was another good entry point.

Episodic pivots on INFY

A reader asked me my opinion on INFY. Now as regular readers know the hazards of commenting on any single stock. Many times those opinion do not matter because what is important is methodology. But I sent him the following chart of INFY with episodic pivots marked on it. My studies show , further away from the episodic pivots you buy, more risky it is. In fact one of the systems I am experimenting with is to use the price move from such episodic pivots to identify possible short candidates.

Episodic Pivots on stocks up 50% plus in a month- Part3