Finding Top Trading Candidates:

(1)

Finding Top Trading Candidates:

(2)

The Problem



We have a finite amount of time and attention.



Where to best deploy resources?

–

Capital

–

Attention

–

Risk



There are, very roughly, 7,000 stocks traded in the US.



How to find the best?



_{(Ideas can be adapted to global markets or other asset}

classes.)

(3)

Know Yourself



There is no one-size-fits-all solution.



_{Who are you, as a trader/investor?}

–

Timeframe

–

Risk tolerance

–

Activity levels

–

Sophistication

–

Specialized knowledge

–

Etc.



All of these factors, and many more, are important to

(4)

Outline



Refine the question of “what to trade” by

understanding yourself.



Consider tools and techniques for filtering trading

candidates.



Ask hard questions (such as persistence).



Look at potential pitfalls and mistakes to avoid.



Consider tools that can help.

(5)

Investment Objectives



Make money, yes, but… how?



_{We will consider four different types of}

traders/investors.

–

Active trader, seeking to take concentrated positions

–

Long term investor, adapting traditional portfolio approach

–

Options trader



_{Premium seller}



_{Directional trader}

(6)

Long-term investor



Seeks diversification

–

“Bad things will happen, but with enough positions, it

evens out.”



_{Ideally, looks for return above index}

–

Sector tilts

–

Individual stocks



Varying risk tolerances

(7)

Active trader



Needs stocks that will move in “certain ways”

–

“Certain ways” depends on trading style



_{Diversification, beyond a certain level, is undesirable}

–

Diversification tends toward index return

–

Most active traders find return comes from concentrated

bets.

(8)

Option premium seller



Needs to sell options with enough premium to be

“worth it.”

–

This is not as hard as might be imagined because the

options markets are highly competitive.



Ideally, will go beyond technical screens

–

At least, will be aware of corporate events.



Specific strategies and structures are outside scope

of this presentation

–

E.g., covered calls, straddles, butterflies, etc.



_{Wants stable stocks.}



Usually wants diversification. (index options?)

(9)

Directional options trader



Wants unstable stocks



_{Relative cheapness or expensiveness of options may}

not be a consideration

(10)

Who are you?

(11)

General Concepts in Filtering



Sufficient Liquidity

–

Avg volume

–

Avg $volume



Sufficient movement

–

ATR

–

ATR%



_{Relative Strength}



Stability

(12)

Liquidity



Why it matters:

–

We want to be able to get in and out when we want to,

without too much slippage.



_{But, there are some cases in which illiquidity may be}

a good thing.

–

Trends are essentially one-sided failures of liquidity



At least, understand the risk of liquidity and consider

how it might change under stress.

(13)

Measuring Liquidity



We use volume as a proxy for liquidity.

–

But is this always good?

–

What might be better?



_{Measuring average bid/ask spread?}

–

Time of day influences?



Active traders probably want 1MM shares / day.



_{Swing traders might be ok, in some cases, under}

500k shares / day.

(14)

Dollar Volume



Average volume, expressed as a dollar amount rather

than shares.



Two calculations:

–

Average volume * current price

–

Average volume * average price (same period)



Maybe more relevant for position traders, but does

give better representation of how much capital could

be deployed.

(15)

Measuring Range



Many traders will include an ATR screen to remove

stocks that don’t move.



This can be good and bad

–

Even intraday traders, who generally need range, will find

good range in “news stocks” which may have been

excluded by any reasonable screen.

(16)

ETPs Bring Some Challenges

(17)

Adjusting ATR for Price



ATR depends on price



_{%ATR expresses ATR as a % of the underlying price}



Two very different risk profiles:

–

Stock A:



$100 with $1.00 ATR



_{1.0 %ATR}

–

Stock B:



_{$10 stock with $1.00 ATR}



_{10.0 %ATR}

(18)

Rough Guidelines for Liquidity



Active Traders:

–

1MM shares / day

–

$0.75 ATR



Position Traders

–

500k shares / day

–

No ATR screen

(19)

Relative Strength



There is validity to being long the strongest and short

the weakest, over a large sample size…



But there are also some potential issues:

–

Mean reversion can often set in at extremes



_{Naïve application of relative strength often runs into}

“snapback” from both strong and weak groups

–

Relative strength rankings will often show strong

sector/industry concentrations

(20)

Simple Return Measures



In most software packages can use Rate of Change

(ROC), which is a simple percent change over a

specified time period.

ROC = Close

_today

/ Close

_{n periods ago}

– 1



A basic relative strength measure can be created as a

ranking of these returns.

(21)

Ranked by One Month Returns



Exchange traded products (ETPs) and their related

markets show some differences.

(22)

Multiple Period Comparison

(23)

One Possible Solution



Rather than use a simple measurement of return,

average several periods’ returns.

–

A good discussion can be found in O’Neil (William O’Neil:

How to Make Money in Stocks

, 4

th

_{ed 2009), but many}

other authors use similar tools.



Many options:

–

Use as few as two or many more periods.

–

Weighted or unweighted.

–

Can implicitly weight by period selection:



_{E.g., 1 week, 2 week, 1 month, 1 year is front weighted}



E.g., 1 month, 1 year, 1.5 year, 2 year is back weighted

(24)

Waverly Advisors’ Relative Strength



We use a front-weighted multi-period relative

strength measure.



Periods and calculation are proprietary, but there is

no secret sauce.

–

The measurement was crafted to be coherent with and to

support our trading style, not because it is better than any

other.



We use this as an idea generation tool and as a filter

for other trades.

(25)

(26)

Ranked RS



The actual RS value may not be especially meaningful.

–

This shouldn’t be surprising:

relative

strength!



Can simply compare a list of RS values to each other to

get a RS ranking.



_{It is also possible to compare stocks relative to a stock}

universe.



_{We do this with a non-parametric ranking:}

–

Create the raw RS measure for each stock in the S&P 500

–

Create the raw RS measure for the test stock.

–

Express the test stock’s RS as a percentile of the S&P 500.



_{Can also be outside the range of the S&P 500}

(27)

(28)

Regions, Styles, and Industries

(29)

Using Relative Strength



Much research shows that naïve relative strength

strategies are not effective.

–

In general, academic research shows this, but whitepapers

written to support marketing of simple relative strength

strategies take a more simplistic approach.



Mean reversion is the “enemy” of a relative strength

strategy.

–

Buying the strongest and selling the weakest could leave

you exposed to mean reversion.

–

Several ways to compensate, but could begin by filtering

(30)

Filtering for Overextension



When markets are stretched far from a moving

average, mean reversion is more likely.

–

Need to define “stretched far”

–

This tendency is different in different asset classes



_{Properly calibrated bands or channels are one way to}

quantify “stretch” from a moving average.

(31)

Waverly Advisors’ KPos Measure



KPos = Keltner Position = the

close as a % of the band width.



50% = the moving average



_{100% = the upper band}



75% = halfway between the

average and the upper band.



Measure can be > 100% or <

(32)

KPos in Waverly Advisors’ Research

(33)

(34)

Keltner Excursion Stats

(35)

KPos as a Filter



Since there is a statistical edge for mean reversion

when a market is outside the channels, one strategy

would be to avoid buying or selling markets outside

the bands.



This would lead to a strategy that is similar to trading

pullbacks.



(Realize these tests work with a wide range of

parameters. The concepts are much more important

than the details.)

(36)

Stability



Consider this progression:

–

Point changes



($1.00 but on a $5 or $200 stock?)

–

Percentages



_{(1% is standardized, but is that “a lot for this stock” or}

not?)

–

Volatility-adjusted measures



_{ATR ratio}



_{SigmaSpikes™}

(37)

SigmaSpikes™



Expresses each day’s return as a standard deviation

of the previous 20 trading days.



Not normally distributed!

(38)

SigmaSpikes™ on a Chart

(39)

(40)

Stability in Our Research



Keep a running total of how many large SigmaSpike™

days over the past 252 trading days.



Few may indicate a quiet (statistically, more

predictable) name.



More may indicate more volatility.

–

4/252 quite likely earnings-driven



This measure tends to be stable, but surprises

happen.

(41)

(42)

How to Use Stability



Large shocks disrupt options pricing

–

This is good for long premium traders and bad for short

premium



_{Can use as part of selection process and risk}

management.



_{Remember, all statistical measures only work within}

the bounds of probability. Surprises happen.

(43)

Screening Tools in

Waverly Advisors’ Research



Equity Trading Model

–

Active stocks



_{Tactical Equity Screens}

–

Big Movers

–

In Play

–

Consecutive Closes

–

RS Strong

–

Consolidating Near Extremes

(44)

Waverly Advisors Screens

(45)

Active Trader



Focus on Equity Trading Model



_{Tactical Equity Screens}

–

Extension

–

Consecutive Closes

–

In Play

–

Big Movers



_{Position screens}

–

Consolidating Near Extremes

–

RS Strong

(46)

Long-term Investor



Market and risk environment context is important



_{Sector and geography tilts}



Specific stock names

–

Consolidating near extremes

–

RS Strong

–

In Play (possibly more short term)

–

Equity trading model (actives)

(47)

Options Traders



Use screens for your timeframe



_{Risk and market assessment matters}



Focus on stability measure that fits your chosen

strategy

–

Long premium players probably prefer more shocks

–

Short premium (long time, etc) prefer more stability

(48)

Summary



Before launching into screening and filtering (which

is made very easy with software) think about who

you are as a trader.



_{What are you trying to accomplish?}



How will you get where you are going?



Understand the tools and techniques, and potential

issues with each of them.

(49)

Waverly Advisors’ Research



Specific systems, broad tendencies, and actionable

ideas in major liquid markets.

–

Futures

–

Currencies

–

Stocks (indexes and individual names)



_{Both trend-following and counter-trend components.}



Applicable to traders working on all timeframes.

(50)

Waverly Advisors, LLC:

Research Products

Tactical Playbook

– Available on Interactive Brokers

–

Written for the active trader on the daily/weekly timeframes

–

Exact trade recommendations



Hybrid systematic-discretionary methodology

–

In-depth technical “drill down” into a set of markets.

–

Bigger-picture overview of all liquid asset classes.

Tactical Portfolio Outlook

– Available on Interactive Brokers

–

Written for the longer-term manager



_{Addresses both the allocator and the longer-term active trader.}

–

Emphasis on executing with ETFs in a long-only and long-short environment

–

Focus on Equities, Equity Sectors, and other asset classes

–

Macro perspective on risk factors and major economic events.

Options Market Outlook

– Contact Waverly Directly

–

Proprietary, quantitative analysis of options market

–

Incorporates both volatility and directional analysis

–

Macro risk factors and cross-asset perspective

–

Actionable trade ideas

(51)

(52)

My Blog

(53)

Contact:

Waverly Advisors

228 Cedar Street

Corning, NY 14830

(607) 684-5300

www.waverlyadvisors.com

[email protected]

Adam Grimes

CIO, Quantitative Analysis, Risk Management

[email protected]

Chris Noye

Managing Director, Head of Sales