Stock Exchange: Are You Growing Your Trading Knowledge Base?

The Stock Exchange is all about trading. Each week, we do the following:

• Discuss an important issue for traders,
• Highlight several technical trading methods, including current ideas,
• Feature advice from top traders and writers, and
• Provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links and ideas to help us improve this resource for traders. If you have some ideas, please join in!

Review: Are You Paying Attention to Market Conditions?

Our previous Stock Exchange asked the question: Are You Paying Attention to Market Conditions? We noted that, on one hand, tuning out market noise is one of the best things investors and traders can do. However, that doesn’t mean tuning out everything. Market conditions obviously do change, and ignoring those changes can be a mistake.

This Week: Growing Your Trading Knowledge Base

Kaizen is a Japanese word often used in business meaning “continuous improvement.” When you examine your own personal trading activities, are you continuously improving? Or at least looking for ways to continuously improve? This week, we are adding a new trading model to our team in our ongoing efforts to continuously improve. And we’ll get into some details and specifics later in this report. But first, some advice on How to Improve Your Trading Results from trading psychologist, Dr. Brett Steenbarger:

“Many traders focus on their results–their P/L–and never make the process changes that could lead to sustained results. A great deal of writings in the area of trading psychology emphasize the changes that traders should make–not actual techniques traders could employ to make those changes.”

Steenbarger goes on to share some proven techniques for building your positive psychology, including: Positive Exposure Therapy, Positive Cognitive Therapy, and Positive Solution-Focused Therapy. Steenbarger’s article (linked above) is interesting and worth a read.

Model Performance

We are sharing the performance of our proprietary trading models as our readers have requested.The models are based on a variety of trading strategies as we will review later in this report. They are also often used in combination with our longer-term fundamental investment strategies.

Expert Picks From The Models

Emerald Bay: I picked up some attractive momentum in both Chipotle Mexican Grill (CMG) and Tyson Foods (TSN) a while back, and I continue to hold the shares.

Blue Harbinger: Um, wait a second Emerald Bay; you’re new here. Who are you?

EB: I am a long-only strategy. I seek exposure to the highest momentum names in our large cap equity universe, adjusted for volatility.

BH: Interesting, but since you’re new here, you’re not getting off that easily. Tell me more about your trading program, so I (and our readers) can practice a little kaizen.

EB: My positions are sized based on volatility (with more capital invested in the less volatile stocks). Make sense? I also use leverage from time to time.

BH: Uh. Okay. Sounds clever. How long do you hold your positions? How often do you rebalance?

EB: The positions are rebalanced bimonthly to maintain volatility and risk targets and to maintain exposure to the leading equities. When positions fall out of the portfolio and the market is in a defined uptrend, they are replaced. When positions fall out of the portfolio and the market is not in a defined downtrend, the cash is invested in short to intermediate term treasuries until an uptrend resumes which protects against large drawdowns.

BH: Risk management and protecting against drawdowns sounds good. But I’ll be keeping my eye on you, new guy. Road Runner, what do you think?

Road Runner: Lighten up. Time will tell.

BH: Gee thanks. And do you have any actual trades to share with us?

Road Runner: I bought shares of eHealth (EHTH) near the end of last week. As you know, I like to buy stocks at the lower end of a rising channel, as you can see on the following chart.

BH: You and these rising channels, Road Runner. Do you ever consider the fundamentals. You know… digging in a little deeper to what’s actually going on at the company. For example, I did a write-up last Friday on Goldman Sachs BDC and its reasonably priced 9.1% dividend yield.

RR: Jeff often uses us trading models in combination with some of his long-term fundamental strategies. And yes, I am aware of fundamentals. For example, I know eHealth provides private health insurance exchange services, and it has been growing its revenues very rapidly over each of the last four quarters and easily beating revenue expectations. And by the way, a 9.1% dividend yield?–what are you some sort of haphazard yield chaser?

BH: Give us the kaizen then, Road Runner. How do you pick your trades? It’s not as simple as just buying the dips in a rising channel, is it?

RR: No. It’s a little more complicated than that. I do like to buy in the lower end of a rising channel; but more specifically, I look for a certain type of situation (some call it a pattern, others may call it a setup, etc.) where the probability of a particular action is not a matter of chance (50/50) but has been historically noted to result in a greater tendency toward a particular outcome. “Trending in a channel” is one such situation. An equity will often “cycle” between the upper and lower bounds of that channel for substantial periods of time.

My model design attempts to take advantage of this property by identifying stocks trending in an upward channel and waiting until the stock price drifts to the lower bound, making it a candidate for purchase. These types of situations have a relatively high probability of positive outcome with a reasonable profit potential. And eHealth can be seen to be in this type of a situation. This is a short-term trade that has traditionally shown profitability when the right conditions have been met. One way or another, I’ll be out of it shortly – usually, after about four weeks.

BH: Alrighty then. Thanks Road Runner. Here’s a little more eHealth fundamental data, if you’d like to continuously improve yourself.

Athena: While you two are bickering about your approaches, I have a trade to share. I bought shares of TCF Financial Corp (TCF) last week.

BH: Why? Isn’t that a bank? Won’t the earnings get crushed once our Twitter in Chief strong arms the Fed to cut rates to oblivion thereby destroying TCF’s net interest margins?

Athena: You and these fundamental narratives–jeesh! You can make up a story for anything. I, however, am a emotionless trading model unaffected by your subjective narratives. I stick to the technical data. Specifically, I look for stocks having strong positive trends and then select only those with the very strongest trends (“king of the hill”), constantly replacing the ones with weaker trends. And I generally continue to hold my positions until either the strength of the trend abates or a stock with an even higher trend strength comes along. I don’t have a set “holding period” for a position. I will exit only when either a stronger stock comes along or if market conditions dictate a strong potential for loss – capital preservation remains the key driver in all situations

BH: Interesting. Thank you for sharing. And how about you, Holmes–anything to share this week? You know, in theory, I greatly appreciate your dip buying strategy.

Holmes: I bought CarMax (KMX) on Friday, you know–the day there was a big dip in the market.

BH: Seems like a good day to buy on the dip. How long do you usually hold your positions?

Holmes: Usually around 6 weeks, but that can vary.

BH: Here is a look at the F.A.S.T Graph for CarMax. These charts include fundamental data, and they can be a very good opportunity for you to keep growing your knowledge base.

Conclusion:

For many investors and traders alike, the markets constantly provide opportunities for continuous learning and knowledge base building. And sometimes it can behoove market participants to focus on psychological trading process improvements that can ultimately lead to P&L gains, instead of simply focusing on P&L gains alone. We’ve recently welcomed aboard the Emerald Bay trading strategy in a continuous improvement effort towards kaizen.

Getting Updates

Readers are welcome to suggest individual stocks and/or ETFs to be added to our model lists. We keep a running list of all securities our readers recommend, and we share the results within this weekly “Stock Exchange” series when feasible. Send your ideas to “etf at newarc dot com.” Also, we will share additional information about the models, including test data, with those interested in investing. Suggestions and comments about this weekly “Stock Exchange” report are welcome. You can also access background information on the “Stock Exchange” here.

Trade alongside Jeff Miller: Learn more.