Tuesday, March 19, 2013

Screening Methods

Two issues survived my initial screen of Monday's breakouts, as noted in last night's post. They are Mid America Apartment Communities Inc. (MAA), which broke out to the upside, and Monolithic Power Systems Inc. (MPWR), to the downside.

Both have six-figure average volumes but below the 500,000 level. Both support options, but the open interest is so low as to make options impractical vehicles under my trading rules.

With this post I want to go into my process in some detail so readers can understand how I'm reaching my conclusions.

The initial screens toss out stocks that have even or less historical odds of success in the direction of the most recent  breakout, calculating the odds based on data going back to January 2009, around the time that the broad markets began to recover from the post-recession crash.

In that period, MAA broke out to the upside 19 times, and MPWR to the downside, 15 times.

Both survivors did fine with the odds test, both with a 53% success rate. MAA's winning bull trade's on average yielded 5.8%. MPWR's winning bear trades were less productive, yielding 3.7%.

I also toss out stocks that are within 30 days of an earnings announcement. We're not in earnings season at this point, and so MAA and MPWR passed this test easily.

This morning, an hour or so into the trading day, I checked the two stocks, and found that they were trading beyond their breakout points, confirming the trading signals.

Confirmation is a key point in the process. Everything up through confirmation is based on fixed, non-negotiable rules. A stock must have better than even odds of being profitable over the period back to early 2009, earnings must be at least 30 days out, and the stock must allow entry the next day beyond the price channel.

Going forward, my methods are based on flexible preferences.

After confirmation, I did some quick checks on the survivors to see whether they really are worth further analysis.

One method I use is to adjust the average yield by the odds of success to produce a score. I prefer that it be 5% or higher. Both stocks failed that test. MAA had a score of 3.1%, and MPWR, 2.0%.

That isn't necessarily fatal to a stock as a potential trade, however.

Maybe something has changed in recent times that is improving the odds of success.

To understand that, I go to the charts, identify on a weekly chart the start of the present trend,, generally covering the past year or so, and then see how the breakouts fared from that date to the present.

MAA's present sideways trend began Nov. 21, 2011. Since that date, MAA has completed six upside breakouts, half of them successful, for an average return of 2.3%.

MPWR is correcting downward within an uptrend that began Oct. 3, 2011. It has broken out to the downside four times, and only one of those trades was profitable, yielding 1.6%.

At this point, I quickly conclude that neither stock is a viable trade.

I noted above that the analysis after confirmation is based on flexible preferences. They can be over-ridden by other information.

If MAA or MPWR had produced scores of 5% or better when I combined their yield with their success rate, I might have done a full analysis.

If either had been liquid enough for an options trade, I would have considered a trade to be possible, since options leverage the profit and also allow me to hedge against failure.

An interesting chart can prompt me to look further. MAA isn't interesting; it's in a sideways trend. But MPWR is in a pronounced uptrend. Had Monday's breakout been to the upside after a correction, then I might have looked at it further.

But those are counterfactuals. I won't be placing a new trade today, and I am wandering away from my trading station to brew a pot of genmaicha tea and dive into a book about my future, The Plutocrats, by Chrystia Freeland.


My trading rules can be read here.  A discussion of recent modifications to my trading methods, which haven't yet been incorporated in the original write-up, can be found here.

And the classic Turtle Trading rules on which my rules are based can be read here.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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