ABC OF STOCK SELECTION
Each letter stands for a criterion I use in stock selection.
"O" stands for observation. Speculation is largely observation--pure and simple. First, I've observed that higher-priced stocks make larger moves on a daily basis than lower-priced stocks. As a short-term trader, I'm not interested in percentage moves but in point moves. A 5% move in a 100 rs stock is much bigger then 10% move in 20 rs stock.
Second, look for situations in which you can put pieces together, whether multiple signals or recognizing how a long-term pattern has combined with a short-term pattern to create a higher-than-average likelihood for trend continuation.
One of the most important criteria in assembling a hit list is to observe which stocks outperform the rest --which stocks have high relative strength over the intermediate term.
Two shorter-term relative strength methods I developed for identifying the right stocks to trade are intra-day relative strength and day-over-day relative strength. For example, stocks in an uptrend that stay strong as the market falls in the morning are excellent long-side candidates when the market stops going down. If market dynamics reverse, the stock may explode. Also, stocks that remain resilient despite a strong overall market decline are interesting long candidates the following day.
Another observation to make is whether a stocks shows persistence or not. A stock closing near the top of its range benefits the short-term trader, as stocks in fast moves tend to close at or near the high (or low, for downtrending stocks) of the day. Also, the propensity of a stock to have periods of great velocity--that is, to move a large distance over a short period of time--is vital. Short-term traders need to be in stocks that have shown they can move--and move big.
Finally, if a stock consistently trades above its rising 50-day moving average, this is often a good tip-off to a developing strong uptrend.
"C" stands for capitalization. Will create two hit lists. One is for smaller capitalization stocks that typically have an average daily volume of under 300,000 to 400,000 shares.
These small-cap, less-liquid stocks often make explosive moves, as once an institution makes a commitment to accumulate a position (or exit a position), their presence becomes quite evident on the tape. Once an institution decides to get involved, it's not worth their while unless they accumulate a meaningful position. This means size to buy (size bids) on the tape. Stalking small-cap stocks for size bids (and offers) is one of my bread and butter strategies. Size to buy in trending small caps is one of the best trading edges available, but you have to be watching a manageable list of strongly trending names to see what's going on.
"E" stands for expansion of range. Often large moves and new legs begin with an expansion in a stock's daily range, where buyers overwhelm sellers (or vice versa). Further, since the nature of trends is to thrust, pause, and thrust back in the direction of the underlying trend, I'm looking for expansions out of pullbacks or consolidations.
"A" stands for ADX. The Average Directional Movement Index (ADX) is an indicator that measures trend strength (but not direction). Not all trends are created equal. Since the nature of strong trends is to persist, high ADX readings are a valuable tool to help identify which trends may turn into runaways. Pullbacks in runaways usually last no more than a few days. Although those momentum stocks may be very volatile intra-day, for the agile, disciplined trader, this volatility offers opportunity. Since momentum begets momentum, I stalk the highest-momentum names for signs of continuation.
"N"Stands for new highs/new lows. Although many investors are cautious about buying new highs (or shorting new lows), believing the name of the game is to buy low and sell high, momentum players must be willing to buy high and sell higher. A stock must make a new high before a series of new highs is scored. Scanning new multi-month highs and lows will provide many good candidates.
Starting out with a sound foundation of stocks to trade is essential to any trading approach. Selecting stocks that meet the criteria outlined above allows you to focus on a small number of high-potential stocks out of the universe of tradable stocks