How To Pick The Right Stocks

How To Pick The Right Stocks
As a Sell By The Bell member, we are going to spend the majority of our time trend
trading the daily charts to select stocks on the long or short side of the trade. Then, the
next question becomes: how do you determine your outlook? Bullish? Bearish? Neutral?
There are many methods which can help you form an opinion, from gauging the overall
stock market to just a single security. Sell By The Bell uses technical analysis, sector
rotation, economic cycles, stock market sentiment and momentum, studying news events,
volatility analysis and many others. Of course, none of this can predict the future. When
you use any of our trading methods, you are considering two things simultaneously: what
is the current market environment? What do you expect it to be during the life of your
trade? These could be the same or completely different depending on the market
The focus of my work is to create a trading system that can be used repeatedly to book
gains and minimize losses. Sell By The Bell is designed to introduce you to a specific
strategy and to give traders the exact technical tools I utilize to book gains and minimize
losses. I am going to cover the basics of trend trading and the most important technical
tools thru some of our past trades.
Every trader needs a trend to make money. If you think about it, no matter what the
technique, if there is not a trend after you buy, then you will not be able to sell at higher
prices. Trend trading is reactive and systematic by nature. Trend following does not
forecast or predict markets or price levels per se because prediction is impossible in the
stocks markets.
Trend trading demands that you have strong self-discipline to follow precise rules. It
involves a risk management system that uses current market price and current market
volatility. Past performance is not indicative of future results. As such, no system is
perfect. Trading involves risk. With all the technical tools that are going to be revealed to
you, there are market forces beyond our control that can move the markets or simply
shake you out of your trade.
Our trading system analyzes the three critical issues that confuse traders the most. These
1. How and when to enter the market.
2. How to exit the trade if it becomes unprofitable.
3. How to exit the trade if it becomes profitable.
Here is the epitome of why the market can baffle so many people, so much of the time.
On February 17, 2011, a friend of mine asked me "You maintained a cash bias on
February 17, 2011 with CRM trading near $142.00. Why did you begin your short
position? If we are in a bull market, shouldn't we just stay invested and not go short on
Since a picture is worth a thousand words, here is the daily chart of I will
begin our answer with a hypothetical example from history. The real world example
below is similar to our current situation: (a) the market pulled back, (b) we invested some
cash near the red down candle, (c) the market reversed, and (d) we began to implement
the incremental approach by stepping away from risk as the market continued to drop.
The hypothetical question above would apply to the situation below.
When the market became extended and peaked in the daily chart above, nobody knew
how fast CRM would tank. Incrementally stepping away from risk as a bear market
unfolds eventually leaves you with a 100% cash position. The chart above proves that no
matter how strong a stock may appear, they can be subject to severe volatility that will
eventually trap both bulls and bears with very few survivors in the process.
As of 2012, we are in a bull market and until proven otherwise, the markets will most
likely continue to make higher highs. However, regardless of what you feel or how much
you study the markets and the economy, no one knows the day when (a) a new bear
market is starting, or (b) when a significant and painful correction has kicked off
(remember the "flash crash" correction of 2010?).
We can understand when the odds of a correction have increased or when a bull market
becomes long in the tooth, but bull markets can go on much longer than rational analysis
would forecast (think the NASDAQ between 1998 and March 2000). When the odds of a
correction become elevated, as identified by technical indicators one would use, we do
not know (a) how long a correction/bear market will last (three days, three weeks, three
months, or three years), (b) the magnitude of the correction/bear market (7%, 17%, 37%,
47%, 57%, etc.), or (c) if a correction will morph into a full-blown bear market.
Possibly the biggest difference between seasoned professionals and the typical investor is
the ability to raise cash at the proper times. You want to raise cash early in a corrective
process and in the early stages of a bear market. Unfortunately, we all have heard too
many stories from people who rode a bear market all the way to the bottom and sold out
at close to the worst possible time.
If you are managing your own money or have a money manager, YOU or your manager
better be able to answer this question in detail and without any hesitation:
If we head into the next crisis which leads to losses approaching 50% or greater again,
how would you protect capital?
Investing and/or trading is not about great forecasting, protecting your ego, or being right
- it is about making money and protecting capital. In order to do that effectively, you
need to be extremely flexible, agile, open-minded, and willing to buy on a Tuesday and
sell in the blink of an eye if the situation has changed enough to warrant such action. That
type of flexibility requires that you push your ego aside and be able to understand, in
advance, that any buy or sell decision, taken in isolation, may turn out to be "wrong".
If you expect to make the proper decision in the markets 100% of the time, you will be
very frustrated and lose incredible amounts of money. It is important to manage the socalled "wrong" decisions with an open mind and quickly be able to raise cash or buy back
in when the market presents new information.
For those who have worked very hard to build up their savings, protecting your assets
from devastating bear markets is of uppermost importance. There is a difference between
accepting normal "give backs" and short-term losses in order to profit from a bull market,
and letting the losses run out of control to a point where you have significantly damaged
your net worth.
The following month the same investor asked another excellant question:
"What is more important? Capturing 100% of the market's upside 100% of the time, or
even beating the market 100% of the time?
Capturing a respectable return when risks are higher, protecting your net worth when
needed, and not having to live through losses in excess of 50% during the next bear
If you want to capture 100% of the market's upside 100% of the time, you must also be
willing to accept 100% of the market's risk 100% of the time. That may be the right
strategy for some people, but it is not our approach to growing and protecting capital. We
might add that our approach allows for much better sleep at night. This basic concept is
known as risk-adjusted returns. A return must take into account the amount of risk you
had to take to capture the return.
With the problems in in our economy today, I will continue to use the incremental
approach until the market and the economy can find its footing again, which may occur
today, in two weeks, two months, or in two years. As you can tell, becoming a successful
trader does not happen in a day. If you know this going into your journey of becoming a
trader, then you can save yourself alot of grief. Be patient with yourself. Do not trade
with real money until you know you are making money consistently.
Congratulations on making the decision to become a trader. The majority of people know
almost nothing about trading stocks or simple technical analysis. As such, they GIVE
their money to strangers to manage it for them with dubious results. They have a belief
they cannot time or trade the market successfully so they leave the trading to
professionals that are licensed on the whim that they can do it better. They are told to be
happy with bad results because "They are in it for the long term." Understanding the
trading methodology in Sell By The Bell will turn anyone who practices the disciplines of
technical analysis into a superb trader! Now, lets study the foundations of the Sell By The
Bell trading system thru past winning and losing trades.
The Sample Trades
Las Vegas Sands (LVS) We shorted LVS at 54; The stochastics indicated the stock was overbought.
Simultaneously, volume was declining while the stock was rising. Finally, LVS was
trading at thirty dollars above its 200SMA. This was a very serious red signal so we
decide to go short. End result: We covered at 51 the next day for a gain of +8.0%
Medivation (MDVN) I bought MDVN at $20.00 per share and sold it at my first target of $21.74; I made
$1774.00 in the blink of an eye. We see RSI, Stochastics, MACD, all confirm the trade
was a go. Here is the important part: look at the volume bar and the truth comes out! This
was conviction buying at its finest. Classic buy the dip and sell the rip. It certainly did
look toppy but markets can remain irrational alot longers than investors can remain
Discover Financial (DFS) Take a look at that trendline because it is one of the most tradable patterns in the stock
markets. Yes that is a Bull Flag. Initially, I thought about buying this Discover but felt
that the broader market averages still needed some time to correct so I decided not to buy
yet. MACD was trending lower, As was the RSI. But if you look at the volume bar you
will see that the stock was declining on low volume so I felt a tst of the 50 day SMA was
in order. End result: the market opened on a gap down and DFS traded within 20 cents of
the 50 day SMA so I decided to buy 1000 shares at $22.56 and sold the stock at my target
of $22.88 and booked $207.00 after commissions.
JP Morgan Chase (JPM) Ok gang, since a chart is worth a thousand words, lets take a look at JPM. I have circled
something important: the stock price is going down while volume has picked up
tremendously. This is a bad omen for this stock. Additionally, there is a clearly defined
double top pattern as the chart shows. The momentum indicators have turned lower like
the MACD and RSI. As such, everything about this stock is bearish and I didnt feel like
buying the dip until the saw the stock price flattend out a bit. End result: no trade in JPM
General Motors (GM) Here is the daily chart of GM. Well, I guess the stock is in a clearly defined downtrend.
As patriotic and public spirited as I am, I will not buy a stock with a pattern of lower
highs and lower lows. Classic malinvestment; although I drew a trendline that indicates
that if GM breaks above 33 with buying conviction, I would consider trading it on the
long side. End result: No trade.
Youku ADR (YOKU)
As we become more and more globalized you are likely to come across American
Depository Receipts (ADR's) these are international companies who choose to list on
aither the NYSE, NASDAQ, or AMEX. Now they have auditors who look at their books
but I think one must be very cautious when trading these companies; especially if they
are volatile. One such play is YOKU. I first though about buying because it was right on
the 20 SMA; However, upon further review, we notice the MACD trending lower, RSI
moving lower, a pattern of lower highs and lower lows forming plus increased selling
pressure across the market averages so I instead decided to short YOKU at $60.00 with a
plan to cover the next day. End result: Stock gapped down to 58.90 and I booked
Panera Bread (PNRA) Well, I wanted to short this stock because I believed a fast food joint like Panera was
trading at multiples that was far too high. Gang, the market doesnt care what you believe;
the market does what it does and it can remain irrational far longer than you can remain
solvent! Moral of the story, I decided to short PNRA and unforuntately, it was a losing
trade. Why though? I initiated a short at 122.75 and the very next day it gapped up to
$123.60 for a loss of $850.00. The resaon I lost money was my belief that Panera was
overvalued and due to correct. Had I look closer to its chart, I wouldve realized that
PNRA was in an uptrend and odds favored higher prices since its 200 day SMA was not
breached during its corrective process. Had I held on a little longer, it wouldve been a
profitable trade but Ive been in this business a long time and I can tell you that there are
no guarentees in this market. It certainly couldve gone even higher and I consider myself
lucky to have covered. Lesson learned!
Crude Oil Double Short ETN (DTO) Gang, if you ever decide to trade commodities, lets get something straight. Commodites
are pegged to the U.S. Dollar and when the dollar rises, it tends to tank stock markets.
However, when the dollar falls, stock markets rally and so do commodites. If you know
this going in to your trades, you are going to make alot of money. Since I knew the trend
was down for the U.S. Dollar, I decided to short DTO which shorts crude oil.
MACD,RSI, Stochastics, and check out the selling volume! This was the mother of all
shorts! We shorted DTO @$60.00 and covered our short @57.78 for a whopping gain of
$2200.00! One trade! How did this happend you ask? Well, DTO is a Leveraged ETF so
the gains are leveraged to 200% correspondent to the Deutsche Bank Liquid Commodity
index. Caution is warranted here. Think about it. It couldve easily gone down $2.22 for a
loss of $2200.00; but with good technical analysis skills, a short was clearly the right
Intermune (ITMN) This was the best trade of my life! I mustve traded this stock ten times with mixed results
but on that one day in December, 2010 I decided to buy long at 13.77 1,000 shares. I
based my decision in part because biotech stocks were trending higher in general amid a
flood of speculation about potential takeover targets by big pharmaceutical companies.
The technical picture of the stock changed as well. Over the past five months, a basing
pattern developed which tipped chartists off to the fact that a very strong move was in the
future for Intermune. Then the FDA announced approval of Intermune's flagship drug
Pirfenidone and ITMN exploded to $35.00 per share for a gain of $146.00% in one day!
Theres something to be said for buying on the rumor and selling on the news!
Having seen some of our past trades, you now know a lot more about stock trading than
most other market particpants. Now it is time to put your new found knowledge to work.
In the words of Friedrich Nietzsche, "He who would learn to fly one day must first learn
to stand and walk and run and climb and dance; one cannot fly into flying." Becoming a
seasoned trader and making lots of money daily is a process not an event. Conduct your
trades carefully with analysis and thought. YOU WILL EXPERIENCE SETBACKS
from it every day. In due time, you will become a great trader and economist.
Happy Trading!
Jeremy Scott