A reader has expressed incredulity over my not finding any breakouts in my stock scan today. "Look at thus-and-so," he writes.
It's a reasonable question. There are a lot of stocks out there, and even this close to a holiday, it seems incredible that none were on the move.
Yet, I stand by my claim in Thursday's Top Prospects: "... there are no breakouts beyond the 55-day price channel among the 300+ stocks and exchange trade funds I screened."
Any trader faces an embarrassment of riches: There are always more potential trades than there is money to pay for them. The trader has to pick and choose.
In setting up my trading methods, I've tried to find ways of choosing that also contribute to giving me an edge. I don't know the future. No trader does. So anything that gives me some slight advantage is worth seeking out.
The first element in my toolkit for selecting trades is the universe of stocks that I look at. It's possible to find platforms that will search through every stock traded and give you a list of 50 possible trades.
That's not my style. I limit my stock scan to issues that are on the Chicago Board of Options Exchange penny-increment list.
It used to be that options prices moved in increments of a nickel or dime. The CBOE penny-increment program sought to reduce the granularity to as little as a cent. So a spread can be $2.96 bid vs. $2.98 ask rather than $2.95 vs. $3.00.
This finer granularity to the pricing can give me an edge in options of a few cents per share. Multiply that by 100 shares per options contract and who knows how many trades a year, and it adds up.
Moreover, stocks on the penny-increment list tend to be very liquid. Generally, the higher the liquidity, the narrower the spreads, and the greater my edge, because I'm not paying as much for the privilege of opening a position.
In addition, I also screen a selection of exchange-traded funds focused mainly on markets outside the United States and on commodities. They often lack liquidity, but they make up for that by adding diversification to the mix. The more markets I'm trading, the less likely I am to have all of my positions hit by a contrary move.
Moreover, I limit my scan to stocks priced at $5 or more, since these are less prone than cheaper stocks to market manipulation.
And I scan stocks with volume equal to that of NKE or greater -- generally north of 2 million shares a day. The higher the volume, the smaller the spreads and the smoother the fluctuations, generally (although not always).
Put it all in the mix, and I've narrowed my trading universe to about 300 stocks plus change.
I also select based on a specific set of technical analysis rules. When I say "breakout", I don't mean "looking good" or "on the rise" or "might make some money".
To be a breakout in my analysis, a stock's price must move beyond the 55-day price channel. There are also other rules that further limit which breakouts get a place on my Top Prospects list.
See "How I Trade" for a complete explanation of my trading rules.
On a normal day, when the market is trending sideways, I'll usually end up with fewer than half a dozen breakouts. When the market is trending broadly, it can be as many as a dozen or so.
All in all, it's a very small harvest from the immense pool of stocks that are traded on the U.S. exchanges. And that's exactly how I want it.
The biggest problem faced by any trader is span of control. I can only manage a limited number of positions. If the number grows too large, then I find myself spending more time on portfolio management than on analyzing potential trades.
So when it comes to the number of stocks that make my Top Prospects list, small is beautiful. And on a day like today, when the markets were quiet, and perhaps even comatose, the fact that I found no breakouts that met my criteria shows that my system is working.
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