lecture 10: Trading Strategies & Portfolio Management

Question 1

Choose the right market (security) to trade based on costs

Answer 1

Time consumption, opportunity costs, trading losses from learning curve – trading is a full time job!

Set up costs; computer, high speed internet, trading platform order execution, chart service.

Commission, slippage, missing orders in fast markets, errors.

Unexpected events – order entry going down.

Question 2

Choose the right market (security) to trade based on personal risk tolerance

Answer 2

Leverage use

futures vs. stocks

going on margin

Question 3

Choose the right market (security) to trade based on personal risk suitability

Answer 3

Based on your experience and personality.

Choose “slower” or lower risk markets when starting.

Question 4

Choose the right market (security) to trade based on personal risk volatility

Answer 4

The more volatility the higher the potential profit but the greater the potential costs.

Question 5

Choose the right market (security) to trade based on personal risk volatility

when are most profits made?

Answer 5

The breakout from low to high volatility is where most profits are made.

Question 6

Choose the right market (security) to trade based on personal risk liquidity

Answer 6

Ability to transact a large number of shares without bringing about a large price change

Question 7

Choose the right market (security) to trade based on personal risk liquidity

what is it dependent on?

Answer 7

Dependent on bid-ask size, as narrow spreads does not always guarantee liquidity

Question 8

Choose the right market (security) to trade based on personal risk volume

Answer 8

You want issues with heavy volume that have liquidity

Question 9

3 Types of trading for different time horizons when trading

Answer 9

1. scalping
2. day trading
3. swing trading

Question 10

scalping

Answer 10

Taking very small profits between bid-ask spreads and accumulating liquidity credits.

Requires time, an excellent order entry system, and experience.

Extremely short term (minutes) and fast paced.

Competition between the trader and the market makers, specialists

Question 11

Day trading

Answer 11

Trading an issue and closing all positions by the end of the day, therefore not taking any overnight risk.

“Screen trading” by using intraday technical analysis signals.

Very short term minute and hour bars are used

Question 12

Swing trading

Answer 12

Catching small trends or counter trends over several days or weeks.

Less experience required in comparison to day trading.

Entry and exits can be predefined using pivot points, 2 bar patterns, candle patterns, crossovers etc.

Not as short term, less time consuming

Question 13

Two approaches used to select which issues for investment

Answer 13

1. Top Down
2. Bottom Up

Question 14

Top Down approach

Answer 14

Selection starting from the type of market (stocks, bonds) → country → industry sector → security

Relative strength analysis, intermarket relationships

Question 15

Bottom up approach

Answer 15

Security → industry sector → country

Security selection first also based relative strength and additional screening criteria

Question 16

Other Measures of Relative Strength

Answer 16

Percentage change

Trend Slope Method

Levy method

Question 17

Percentage change

Answer 17

Use a 6 month price change to determine relative strength.

Stocks are then sorted based on relative strength.

–> Higher decile stocks continued to be stronger for the next 3-10 months

Question 18

Trend Slope Method

Answer 18

Calculate the slope of each stock’s price curve in percentage terms over a specified period through a linear regression

Stocks are then ranked by their slope

Question 19

Levy method

Answer 19

First calculated the ratio of a stock’s current price / 131 trading-day moving average, he later changed to using the 6 month moving average.

Then ranks this ratio against the same ratio for all other stocks.

He concluded that relative strength is a better selection process in bull markets.

Question 20

Stock screen selection methods of the Pros

Answer 20

Kirkpatrick

Value line

Wyckoff

O’Shaughnessy

Question 21

Kirkpatrick

Answer 21

Calculated all relative price ratios to each other; P/S, 6 month RS.

Used a multifactor model of the above relative rankings and outperformed by 4:1 vs. the S&P 500 over the last 27 years

Question 22

Value line

Answer 22

Analysis service that uses a proprietary relative strength ranking of 1 to 5 to rank the “timeliness of stocks”.

They also incorporate additional factors such as; earnings trends, recent earnings, earnings surprises.

Outperformance of 16:1 vs. S&P 500 since 1965.

Question 23

Wyckoff

Answer 23

He believed stock prices were determined solely by supply & demand, and influenced by wealthy individuals and large institutional insiders.

He used many tools; bar charts, P&F charts, relative strength, volume.

He believed markets travelled in waves and calculated % price changes from wave highs and lows

Question 24

O’Shaughnessy

Answer 24

Relative price strength was the factor that consistently beat the market. Calculated 12 month relative price strength.

Also studied factors such as; mkt cap, P/S, P/B, P/S, dividend yields, earnings, ROE and developed multi-factor investment strategies.

Question 25

CANSLIM – The Fundamentals

C - Current Quarterly Earnings

Answer 25

+25% or more in recent quarters

Research shows earnings growth is the No. 1 indicator of a stock’s potential to make big gains.

–> That’s why it’s important to look for stocks with strong current results, as well as history of solid earnings growth

Question 26

CANSLIM – The Fundamentals

A- Annual Earnings

Answer 26

25% or more in each of the past three years

Question 27

CANSLIM – The Fundamentals

N - New Product, Management, Highs

Answer 27

Explosive stock growth doesn’t happen by accident. The biggest stock winners hadnewproducts,newmanagement ornewconditions in an industry that propelled the company to astounding height

Some investors pass over a great stock because it’s already reaching a new price high. But that’s precisely the point where many of the best stocks gain steam and begin their biggest price moves!

Question 28

CANSLIM – The Fundamentals

Supply and Demand

Answer 28

The most basic economic principles is the law of supply and demand and one of the places its power is most sharply demonstrated is in the stock market.

Strong demand for a limited supply of available shares will push a stock’s price up. On the flip side, an oversupply of shares and weak demand will cause the price to sag.

Question 29

CANSLIM – The Fundamentals

L - Leaders: Choosing To Win

Answer 29

Steer clear of stocks that are laggards. In the stock market, that sad-looking stock at the bottom of the pack often just falls further behind the leaders

But when you choose stocks that have solid fundamental characteristics — like earnings growth and profit margins — and are thriving in the best sectors, your prospects are better because you are selecting “institutional quality” stocks that get noticed by the biggest traders — the institutional investors like mutual fund and pension fund managers

Question 30

CANSLIM – The Fundamentals

I Institutional Sponsorship

Answer 30

Big institutional investors, like mutual funds, hedge funds, banks and insurance companies, are the driving force behind much of the trading activity in the stock market

Question 31

CANSLIM – The Fundamentals

M - Market Direction

Answer 31

Buying a stock during a market downturn can be like trying to swim against the ocean tide: You might make some progress, but the going will be tough, and a big enough wave of selling could drown you