Stock Screens and Signals

With a rally coming together over the past week, I want to review two distinct and important elements of the buying process. Before I jump in, let me say that I don’t claim to know if this is The Time to buy or not. I do want to give you two steps to consider when making that decision for yourself. They are:

Screening for candidate stocks
Signaling the time to buy (and sell)

This first, stock screens, is more time invariant – a fancy way of saying the list doesn’t change much day to day. In fact, you may not want to change you stock list much year to year as there is a lot to be said for getting to know a handful of stocks inside and out. If you’re like me, you itch to scan a huge number of stocks to see offer up the best opportunities. Of course, you can do both. I have my screeners delivering new stocks every day and I also have my favorites that I’ve gone back to so many times over the years that I am part of the reason support and resistance works because I know from memory what is a low buying price and when to take the money and run. On the other hand, a decidedly Bad Idea is obsessively returning to a stock on which you lost thinking that it “owes you”. This is where an objective plan can really save you.

Sit down at a quiet time and think through the things you want in your candidate stocks. I consider three categories: practical matters, fundamentals, and technical screens. Other folks might want to consider social values, or what their friends say, or worldwide demographics. I have a hard time making the last three objective myself.

On the bare-bones practical side:

Volume is a very measurable criterion that is almost pointless to test. You need enough volume to get in and out. Period. I like to see at least 500,000 shares traded per day.
Price is another area where it’s very easy to be objective – at least at the extremes. If you want to be a penny stock trader – great! Go be the best. But most people choose $1, $5, or $10 and say it’s as low as they go.
Your risk limits drive a price/volatility limit. If you risk only 2% of your account per trade (and that’s being generous), you can’t get into any stock with an average true range bigger than that amount.

Do fundamentals matter or is the sum total of available information reflected in the price? You will have to make your own decision on that, dear reader, because the fundamental data I had at my disposal last I looked was not clean enough to make a good determination. Even so, I do use fundamentals as a tie-breaker for the times when I get too many signals at once. Then I’ll take the signals on the stocks with fundamentals (and story) to my liking. A better way is to refine the objective rules to come up with just the right number of stocks to fit your account.

Technical stock screens are an important component of your plan. They can and should be tested thoroughly. First define what you want, say stocks in an uptrend, or beaten down stocks, or stocks trading in a nice range, whichever. Then figure out which tool from technical analysis delivers the best candidates for your needs. This means know how well the various technical analysis tools have performed. This applies whether you are picking the short list of stocks you will grow with for the next couple years, or setting up a daily screen. If it’s done right, your technical stock screener can give a solid list of candidates. Remember, the point is not to go out and buy all of these right away, but instead to stalk them for the right time to make your move.

For example, a moving average can function as a stock screener, where stocks above the moving average are said to be in an up-trend and stocks below the moving average are said to be in a downtrend. Many experts recommend buying only stocks which are above their moving average, although some will say you can capture more of the move by getting in well below the averages. Of course the advice varies on which length of moving average and what you use may depend on whether you have a short- or long-term outlook. Click here to order your copy of the BackTesting Report on moving average stock screens and find out which moving averages have potential and which have not proven out as a stock screener.

This post talks about screens stocks to build a candidate list that is bigger than you can use at any one time. The examples — price, volume, above/below moving averages — showed objective, testable tactics that can identify out a candidate list. But the stock screener doesn’t pinpoint the time to buy. For that we need a more precise entry signal which I’ll discuss in the next article.