The lesson was well learnt. The art of being successful in stockbroking is to prioritise; whether it is analysis of corporate results or technical analysis. Be mean and selfish with your time, ensure that you have all the elements in place to make quick and decisive trading or investment decisions. Nobody cares how you come to your decisions. It is therefore up to you to become proficient as a trader.
However, this does not mean that carelessness can become the order of the day. Instead, it directs you to develop a system that you can rely on to use continuously to enable you to make constant profits.
How you do that should be your secret.
So, where do you start I your establishment of Step 2 in the Six Steps to Trading Like a Pro? In the previous chapters Step 1 outlined portfolio strategy, which was not outlined in isolation to Step 2. Remember that each step in the process outlined in this book for you to become a successful trader is inextricably linked to other steps.
As such, a strategy to identify companies to trade (Step 2) must be in sync with your personally defined portfolio approach.
This chapter sets out two linked methods to choosing stocks. Understand that these methods are meant as filters to select many stocks and then to remove those that do not meet your trading or investment criteria. There may be stocks that you wish to add to your watch list that have been eliminated by the filter – that is your prerogative.
Where should we start? I believe that a good place to start your company search is with a scan of the general market conditions. The decision process in trading any market should always include a
top-down logic, which essentially means scanning the global economic and market arena, honing that down to the region and then the country in which you wish to trade. This macro-economic search is then filtered down to micro-economic conditions, which includes company analysis.
Macro-economic: involves analysis of the whole economy and includes total amount of goods and services produced, income earned, level of employment of productive resources and general behaviour of prices.
Micro-economic conditions: involves analysis of individual consumers, firms and industries in relation to distribution of total production and income.
The variables you select to enable you to ultimately filter down hundreds of companies to a reasonable few, is entirely subjective and, admittedly, no single approach, is wrong or right.
There are traders who will only buy JSE Top-40 stocks, or mining shares or higher risk so-called penny stocks. That is their filter. What I am proposing is a filter to enable you to choose shares from the entire spectrum of companies listed on any stock exchange.
Finding interesting patterns is equivalent to finding “landmarks” in the price action. For some, an interesting pattern may be a peak or a valley in the prices. For others it may be the shape of a set of candles. Non-traditional charts can facilitate this process. Once selection of the trading instrument has occurred, determining entry and exit points are logical next steps. The resulting trade can be a win, a loss, or a break-even. At any period of time, the trader needs to be able to assess the total performance and identify strengths and weaknesses that occurred.
Note that this chapter ignores risk issues and variables that influence specific ideologies. The following proposed filter is aimed at reducing the vast number of investment and trading potential to a select few. It is my recommendation that traders use the following filter to hone down to those few stocks and then to implement their personal filters.
Aim of filters: to reduce the emotive element of choosing companies.
A filter is a cold factual tool that ignores the host of conflicting forecasts, bullish fever and bearish panic. In addition, many professional traders say that developing and implementing a filter is equal to having a plan, which is better than novice traders who simply throw themselves into the market armed with a few “well chosen” technical indicators.
Therefore, traders are not asked or advised to ignore events that take place in the market, such as strike action hampering share prices or natural disasters influencing corporate action. It is suggested that a filter incorporate such events as an additional plan and not be the sole means of trading.
Phase 1: Find Growth Sectors
The main thrust of the proposed macro-filter is to identify sectors or Indices that are showing high growth when compared to other Indices. Why would a trader want to trade or invest in property companies if the sector is telling him or her that the market is sluggish, or in a downward motion? The aim is therefore to first select sectors by identifying indices that are showing positive growth. The question that must be asked, therefore, is where are investors buying? Will such trading, as a combined number, surely reflect in a growth in the overall sector? How do we find what traders’ sentiment is toward shares?
The answer is to identify sectors that are growing by looking at volume growth in the Indices. The secret is that not all companies listed in a sector forms part of the Index. So, we are immediately eliminating smaller and thus higher risk shares within sectors by choosing Indices. The first filter is thus to identify which Indices have the highest volume growth.