Stock screening trading strategies

Any trading strategy starts with a universe of securities from which you can make your selection. It's often easy to pick the universe of securities you are going to trade but harder to know your picking the right ones.

With so many securities to potentially choose from, and the vast array of factors which can influence the price of a security, where do you start? Stock screening is a basic stock trading strategy that involves the trader screening the entire universe of securities for potentially favourable investments.

Just like sifting through a bucket of sand trying to find pieces of gold, the same approach is used to reduce your universe of securities into a more favourable selection. After you have reduced the universe of securities you can continue your filtering process until you find the most attractive candidate for trading.

From a purely technical standpoint, a stock trading strategy might involve a periodic screening of the universe of securities. This screening process highlights those candidate securities which require further analysis. This is the first step in the technical stock screening process.

This can be a very time consuming task without the right tools. A technical trader would utilise charting and stock analysis software to perform this type of screening. For more information on stock analysis software please review this topic in the knowledge base [Click Here]

Filtering or Zeroing in
The stock screening method you employ will either be a filtering exercise or it will be an attempt to zero in on specific trading candidates which meet a certain trade entry criteria. The filtering exercise aims to only produce a preliminary list of securities which are flagged for further investigation. This is the basis of the "top-down" approach and is a very common stock trading strategy amongst technical traders.

Zeroing in on the other hand attempts to highlight only those securities which are actual trading candidates or have met a specific trade entry criteria. In this instance the filtering criteria is tuned to the traders particular trading style and preference, taking into account:

1. Frequency of trading/trades.
2. Trading capital available.
3. Trading system entry criteria.

The zeroing method is primarily utilised by system traders who have defined entry criteria. Performing a scan of the universe highlights those trades which should be entered based upon trading system rules. For more information on trading systems [Click Here]

The "top-down" approach trading strategy

The "top-down" stock trading strategy attempts to first identify those areas of the market which are performing their strongest and then to identify possible trading candidates within that particular segment of the market.

Let's follow this through with the use of an example. A technical trader can select from an entire universe of securities from which to choose trading candidates. In this example the universe is defined as all the stocks which are listed on the Australian Stock Exchange (ASX).

This will be a large number of securities to choose from (>1200), the trader needs to narrow the universe. The next step for the trader is to identify which area of the market is performing the strongest. A technical trader will utilise various indicators and filters based upon only price information to determine which sector of the market is performing the best.

Once the trader identifies the strongest sector of the market, the screening process is performed again on only that sector. The results from this screen will highlight the best performing securities within the best performing sector of the market. The sequence of analysis is as follows:

1. Identify the universe of securities.
2. Identify the strongest performing sector of the universe.
3. Identify the strongest performing securities from this sector.

The "top-down" approach is common amongst both technical and fundamental traders. The most important requirement for a technical trader is to have the right stock analysis software and an accurate database of price information.

The "bottom-up" approach trading strategy

Using the "bottom-up" approach as a stock trading strategy involves first identifying trading candidates directly. Previously we discussed the "top-down" approach which filtered through the universe of securities to find a strong performing sector and then filtered once again to find the most suitable trading candidates within the sector. With the "bottom-up" approach we start at the security level and analyse these securities directly.

The "bottom-up" approach is more adaptive to a fundamental approach to stock trading strategies, we will discuss this later in this topic.

Due to the inherently easy methods technical analysts can use to scan the market for candidates, it has seen the purely "bottom-up" approach dwindle in popularity. The majority of stock analysis programs available have some form of market screening functionality which enables the trader to easily screen through an entire market in seconds.

Examples of technical trading strategies

The following examples of technical trading strategies are amongst the most popular strategies employed by technical traders. Each trading strategy discussed has it's own unique characteristics which make them attractive as potential trading strategies for traders.

It is quite common for a technical traders to utilise the concepts of these trading strategies and employ variations to produce the required entry and exit signals. The most common trading strategies are discussed in more detail below.

Bear in mind that the majority of these strategies were devised in the 1950's and 60's to indicate the overall trend of the market. When these strategies were first devised they were done so with the intention of being "always in", i.e. the trader was always in the market either long or short. The trader would always keep a position in the market at all times.

Of course, the concept of remaining in the market 100% of the time sounds risky. For this reason technical traders also utilise these strategies to provide an indication when it is safe to be in long positions or short positions. Traders not wanting to stay in the market all the time use these strategies to confirm the overall market direction and take trades according to this filter.

Channel Breakout trading strategy

Traditionally the channel breakout strategy is one of the most common amongst technical traders. The concept behind a channel breakout system is that markets like to trend and the most profitable way to trade a trend is to identify the beginning of the trend and enter accordingly.

A channel breakout system utilises a channel surrounding the price of the security above the price and below the price. The price of the security is placed inside the channel. The picture below shows a security plotted in between two channels.

There are many different ways of calculating the channel limits. For example, the channel that is shown above is a Bollinger Band. The Bollinger Band is an extremely popular channel used in technical analysis, an interesting concept of the Bollinger Band is the inclusion of volatility in it's calculation.

When the Bollinger Band was created in the 1970's by John Bollinger volatility in the market was assumed to be constant. John Bollinger created the Bollinger Band to include a calculation of the securities volatility which quickly made the Bollinger Band one of the most popular channels used in technical analysis circles.

A technical trader will assume the relation of the price to the channel as an indication of the securities direction. A technical trader will use this information to trade in and out of the market. This is the basis for a channel breakout system.

Author:

Perhaps one of the most successful mechanical trading systems ever designed. Based upon a trend following technique it helped Richard Dennis to become one of the most famous commodity traders of all time. The success of the "turtles" in the market enabled 14 traders to return an average compound rate of return of 80% in four and a half years!

Read and learn more about the original turtle rules in all their glory!

Author:

A very interesting interview with an "anonymous" successful person and about his views on real time quotes and trading systems.

Moving Average trading strategy

A moving average trading strategy is one of the first strategies which technical traders learn. The concept of a moving average trading strategy is very simple and this technique is most suited to markets and securities which trend well.

Two moving averages of the price are plotted on a chart. Both moving averages are different in time-scale, i.e. a 21 day moving average of the close is plotted with a 13 day moving average of the close. The following picture shows an example of a moving average trading strategy.

The picture above shows two moving averages plotted against a securities price. A 7 day moving average of the closing price (Red line) is plotted with a 21 day moving average of the closing price (Blue line). The concept of a moving average trading strategy is to buy when the 7 day moving average crosses above the 21 day moving average. Likewise a sell is signaled when the 7 day moving average crosses below the 21 day moving average. We have illustrated a single trade with a green arrow representing a buy and a red arrow indicating a sell.

Of course, you can use any combination of moving averages you like to signal entries and exits. Generally the longer your moving averages the fewer trades and larger trends you will capture, the opposite can be said of shorter moving averages.

The moving average trading strategy generally works best in markets which trend strongly.

Author:

There are many ways of using moving averages to trade but by far the most common method is to trade when a short-term moving average crosses over a longer term moving average. For example, if the 10-day MA crosses above the 30-day MA we typically assume that we have a new buy signal.

Relative Strength trading strategy

The relative strength indicator (RSI) is a popular oscillator developed by Wells Wilder in 1978. It has been developed into a very popular trading strategy amongst technical traders.

The relative strength indicator measures the internal strength of a single security. Most stock charting programs come with the RSI as a standard indicator, such is it's popularity.

The picture above shows an RSI indicator plotted against a security. The traditional concept behind the RSI as a trading strategy is to purchase the security when the RSI crosses above 30 and to sell when the RSI crosses below 70. Of course, interpretation of the RSI indicator comes down to each analyst.

The RSI indicator can be plotted based upon any time frame. When Wilder introduced the RSI he recommended using a 14 day RSI, today the 9 day and 25 day RSI have gained popularity. The shorter the time frame of the RSI the more volatile the indicator and thus the more trades which would be signaled.

Author:

Author:

"The Trend is Your Friend" is a tried and true market adage that is indeed one of the most valuable futures trading tenets. However, history shows that most markets tend to move in a non-trending, or "sideways" fashion more of the time than they are in a trending mode. There are several methods by which to trade non-trending markets. One popular method is called "swing trading."

Author:

The Percent Range (%R) technical indicator was developed by renowned futures author and trader Larry Williams. This system attempts to measure overbought and oversold market conditions. The %R always falls between a value of 100 and 0. There are two horizontal lines in the study that represent the 20% and 80% overbought and oversold levels.

The fundamental approach to stock trading strategies

A fundamental approach to a stock trading strategy in the market takes into consideration all factors which may affect the price of the security. Fundamental traders/investors are guided by the premise that every security has a certain intrinsic value. This intrinsic value can be determined by assessing the earning capacity, market share, business model and many more factors relating to the security.

A fundamental analyst will determine the current market price of the security to be either above or below this intrinsic value. When the market price trades below the determined intrinsic value the security is said to be "undervalued", the opposite is said when the security trades above the intrinsic value.

A fundamental analyst tries to capitalise upon any market mispricing. The belief is that prices will always revert back to their intrinsic value. Market equilibrium is said to be obtained when the market price of the security represents the average intrinsic estimates of all investors.

The "top-down" approach trading strategy

A fundamental "top-down" stock trading strategy is closely related in concept with its technical namesake. The only significant difference are the tools used for analysis.

A fundamental analyst, using the "top-down" approach takes a "macro to micro" view. Starting with the broader economy and working their way towards more micro-level factors of the security.

A "top-down" fundamental approach will always begin with an analysis of the local and international economy. Analysts should obtain such information which will influence the movements of financial markets. Such information may include the trend of interest rates, the status of inflation, level of unemployment, international trade and more. In fact the list can go on to contain all factors which influence the broader economy.

Once the higher level of information has been processed it should highlight which industries and areas of the economy (in particular the financial markets) are going to benefit the most from these trends.

The final process of the fundamental "top-down" stock trading strategy is to analyse individual securities. Based upon the information gathered from the first two levels of analysis the individual securities that are most likely to benefit should be evident.

At the final stage of the "top-down" approach many fundamental analysts utilise the techniques used for the "bottom-up" method.

The "bottom-up" approach trading strategy

A "bottom-up" stock trading strategy focuses directly on the securities fundamentals. This approach is opposite to the "top-down" approach and is a "micro to macro" for of analysis.

An analysis at the company level will take into consideration such factors as the companies products, market share, earning momentum and forecasts, balance sheet, cash flow, control of debtors and the list can go on to include all factors which influence the securities price at the security level.

The "bottom-up" stock trading strategy is the most popular fundamental method employed by analysts. It does however require a large commitment of time and effort to produce a detailed financial analysis of each security. To make this job easier on the analyst fundamental research is divided into two main categories, growth and value securities.

Growth Securities
Securities which are classified as "Growth" carry with it investors expectations about above average earnings growth, above average valuations. Analysts often expect these securities to perform very well in the future and are willing to accept a higher price premium for this expectation.

Value Securities
Value securities have characteristics such as very strong financial's and established history of earnings and earnings expectations. Analysts endeavor to capitalise upon any mispricings in the security based upon sound fundamental valuations.

It is very common to find that a security in the market exhibits characteristics of both growth and value. The "bottom-up" approach does not try to make a clear distinction between the two when this occurs.

Technical Analysis for Fundamental Analysts

Fundamental analysts are faced with a daunting task whenever they set out to find investment candidates. To research and sift through fundamental information such as annual reports, new stories, earnings forecasts and analysts recommendations can be a very time consuming proposition.

With the aid of technical analysis a fundamental analyst can streamline this process to filter suitable investment candidates. As previously mentioned a technical analyst using a top down approach to filter out suitable trading candidates based upon a certain criteria. This same approach can be utilised by a fundamental analyst.

Why the price is a suitable indicator
The majority of fundamental analysts search for long-term investment candidates. The most simple technical indicator of a possible long-term candidate is a steady appreciation in the price of the security.

Securities markets are said to exhibit three forms of efficiency in the way information is disseminated to all market participants, weak form, semi-strong and strong. Market efficiency means simply that the more efficient the market, the greater degree that security prices reflect all the information available which may influence the price of the security. If all the information available is reflected in the price of the security then the securities price would be the most suitable technical indicator to use.

With this in mind, it is clear that a security which has sound fundamentals should experience a steady appreciation in price, as all the information is reflected positively on the security. Using this methodology a fundamental analyst can use technical indicators (i.e price) to filter out only those securities which experience a steady appreciation in price.

After the filtering process a fundamental analyst is left with a list of candidates which can then be used for further analysis.

Examples of filtering methods
Filtering methods which you may like to try include:

Rate of change calculations based upon the price of the security. For example, you should compare the moving average of the price for today against the moving average of the price for x periods in the past. This will screen out those securities which have experienced a steady increase in price over the periods nominated.

Relative strength calculations can be used to determine the strength of a security against a nominated index or another security. This method is useful to determine the strongest performing securities against a standard index. Once again the strongest performing securities would be the ones requiring further analysis.