Finding Hot Stocks
Turn Your Stock Portfolio Hot by Identifying Volatile Markets
By Trader Bob
Short Term Stock Trading, the Ultimate Source for Low Risk High Return Investing
Call: (702) 490 5317
You need a good trading system, but that is only half the battle. You also need a good portfolio and be skilled at finding hot stocks.
We do not like day trading stocks, but we are short term traders and we DO like to hit and run in the US stock market. We like to get into positions when they are moving and then get out in two or three days. And if you are going in and out in 2 to three days you need stocks that are really moving. This is a highly effective way to trade and combines safety with very high yields.
But to do this we use a very unconventional style of trading. We set up a very large group of markets, currently 96, limit our commitment to each market to about $1,000 ($500 traded on margin) and then take mechanical trading signals from a trading system we have programmed. We use a custom trading platform that interfaces with live streaming data from E-signal. We sit in front of a computer for six and a half hours per trading day and we typically take 10 to 30 trades a day.
Our methods are highly margin efficient, that is we only get into markets when they are moving and then we get out in a day or two. For that reason our methods do not tie up our money in dead markets. (see Hit and Run Trading)
For this reason we are able to trade 96 markets comfortably with only $20,000 traded on margin and we have customers trading 15 markets with as little as $3,000.
We work very hard doing what we do but we anticipate annual returns in excess of 100%. In spite of the high yields we are risk aversive and seldom see individual losses in excess of $100. We post all these real time trades daily on our web site at Stock Market Trading Today. You can observe our methods as they unfold on a day to day real time basis.
We do sell our mechanical program and the software to interface it with live E-signal data. (see Automated Stock Trading Software)
But because we take so many trades and are only in trades for two or three days our methods will not work in dead markets. Our methods require that we identify volatile markets. We must be skilled at finding hot stocks.
Identifying hot stocks can be a little tricky. At one time I used a simple form of back testing to do this. I would grab a market, get a couple months of tick data for that market and then apply our trading system and look at the results. If the results looked good I would put the market into my portfolio and if the results looked bad I would discard the market.
The results of this method could be disappointing. A market that had made good money for 8 weeks might produce a string of two or three losing trades just as I was putting real money on it and the market that I had discarded might start making money.
What I soon realized was that this approach was really a form of optimization that was in effect trying to predict future trading system performance by trying to fit a system to a given set of data. It was a form of curve fitting and curve fitting is the worst thing you can do to identify profitable trading. This simply was not a good approach.
But what I realized when working with market data was that the critical factors for identifying profitable markets was volatility and follow through.
I then investigated some commercial software that allowed the user to scan large numbers of markets and enter certain criteria to identify markets that met that certain criteria. I did find this commercial software helpful for identifying volatile markets but the results were nevertheless not as satisfactory as I had hoped for.
The problem was that most commercial software uses range over a period of time to determine volatility. The problem was that sometimes that range took place in a single day or two and the rest of the time the market was dead.
This is an example of a market with a lot of volatility for two days but was nevertheless a waste of time to trade the rest of the time. On 12/16/09 there was some breaking news on DCGN, deCode Genetics, and the market exploded and put in a range from 6 cents to over 30 cents, quadrupling its value in a single day. That is volatility! One day this market was at the top of the list for market gainers but on the next day it was on top of the list for market losers. As I write this on 1/10/10 the market is back to where it started before the news and it is as flat as a pancake. But if you run a volatility scan on all stocks for December 2009 DCGN will probably top the list. And yet it was but a one day wonder and outside that one day it would be pointless to keep it in a trading portfolio.
After some experimentation I hit on a solution to this problem which I will share here. What I did was to develop a program that could scan a stream of data and identify the characteristics that typically work well with our trading methods.
The markets that worked best with our trading methodology, the true hot stocks, were markets that had repeated expanding, volatile break outs with follow through for a day or two. After an expansion of range the market might contract for a few days but this contraction might then be followed by another expansion and then some more follow through.
In order to develop a tool for finding volatile markets I programmed a dummy day trading system. We do not day trade and I am NOT recommending this system for actual trading. But to identify good break out markets for us I set up the following simple rules for the dummy day trading system:
1) The system uses our proprietary programming method for the determining number of contracts traded and limits the size of our positions to approximately $1,000 per position taken. We do this to allow us to trade a large number of markets, currently 96, and thereby protect our trading equity through diversification. Hence we will buy 1000 shares of a stock selling at 98 cents per share but only 100 shares of a stock selling at $10.02 per share. You can see better how this works by examining our twice daily posts of our real time trading at Stock Market Trading Today . We show the markets, how many shares we buy, and the buy and sell prices as the trades unfold in real time.
2) After the close on a given day the dummy system determines the range for that day. It then calculates 25% of that range and adds that value to the close to determine a buy point for the next day. Hence virtually any kind of significant upside move the following day will result in the dummy system buying the market. Typically the dummy system will get a buy signal about every other day and show around ten trades for every 20 trading days or so.
3) A day of entry stop is immediately entered when a position is taken. Using 15 minute bar data this stop will exit a market if it retraces its move more than 75% from the last intraday high. This stop is rarely hit.
4) All positions are closed out on the close of the trading day.
I call this screening device the Breakout Scan and it is included in our trading package and will run on our trading platform.
This is partial results from a good market, BIOF, which was tested on Intra-day data for eight weeks from 11/09/2009 through 1/08/10:
BIOF BioFuel Energy Corp. (NASDAQ) 15 min bars 11/09/09 1/08/10
Total Net Profit = $552
Number Trades = 17
Wins = 10 (59%)
Average profit per trade (wins and losses) = $32.49
This is partial results from a bad market, ARBA, which was also tested on Intra-day data for eight weeks from 11/09/2009 through 1/08/10:
ARBA Ariba, Inc. (Public, NASDAQ) 15 min bars 11/09/09 1/08/10
Total Net Profit = $44
Number Trades = 19
Wins = 12 (63%)
Average profit per trade (wins and losses) = $2.32
When you look at the three month charts of these markets you may be inclined to believe that both markets are volatile and would be good markets to trade. Using conventional methods of determining volatility will probably show that both markets are indeed volatile. But when we apply the BREAKOUT SCAN to the 15 minute charts the difference between these markets becomes apparent.
The bottom line is that BIOF is a great market for our methods, but we are wasting our time with ARBA. ARBA trades well with our methods in so far as we get a good percentage of winners, our winners are larger than our losers and there are no big losers in the lot. But the problem is that ARBA is simply not volatile enough to overcome our transaction costs when trading our relatively small positions. For this reason we must reject this market.
As a rule of thumb when I scan markets with my Breakout Scanner I like to see the average trade (win loss) over $10. If the average trade is less than $10 I reject the market for use in our portfolio.
I have found that this method for finding hot stocks that are suitable for trading with our methodology to be far superior to other methods, commercial or otherwise. Time and time again I have found that markets that show an average trade greater than $10 on the Breakout Scanner will show handsome real time profits with our short term stock trading systems and methods.