Day Trading & Forex Forum

Jack o'Clubs

I know that the majority of T2W members trade intra-day and therefore this may only be of interest to a minority, but a few people ask about EOD strategies and as not everyone has the time (or patience) to trade short time frames, this post might be of some interest.

I've used this method for equities in my own portfolios for some time and it works for me. The 'complete' in the title refers to the fact that it combines fundamental and technical analysis and I make no apology for that. Die-hard technical or equity analysts may choose to go elsewhere although I have more sympathy with the chartists' view that everything is discounted in the price action, than the fundamentalist refrain that 'charts are for sailors', but in my experience the two methods work very well together in longer time-frames. The fundamental element has got me into stocks far earlier than a study of the chart alone would have done, while bearish charts have kept me out of value-trap companies where the analysis lags a deteriorating reality (particularly in recent times). But charts alone would never have triggered an interest in some stocks I’ve owned which have bumbled along for a while not doing much before being spotted elsewhere for their attractions and being taken out by a bidder. I also make no apology for lack of originality either, my fundamental approach will be immediately recognised by anyone who has read Jim Slater’s Zulu Principle books.

Finally I use this approach for a portfolio of long-only UK stocks. However there is no reason why it shouldn't work in other regions, or with a bit of crafty inversion, in identifying stocks for shorts.

So onto the strategy. The first thing is to screen for prospective companies. There are lots of screening programs available, some at great cost, but to be honest the data in the free sources isn't that much worse than the paid-for providers that the price difference can be justified. I would use the customisable screens on the Digital Look website – the data is sourced from Factset which I use at work, so know and trust. What I'm looking for is fast growing companies at reasonable valuations that are cash generating with unstressed balance sheets. There are various ways of looking for these, but I tend to choose low-PEG (ie PE to EPS growth ratio), a sensible PE (to screen outliers), cashflow per share equal to or greater than earnings per share, and a dividend. In Digital Look this is set as a PEG and 12-mth forward PEG of <0.6 (relaxed to <0.75 for FTSE100 large-caps), a PE and forward PE of between 5 and 20, a dividend yield and operating cash flow >0. A quirk of the Digital Look screen is that if you don’t put in zeroes as minimum values in the filters it will also include ‘NAs’ so you need to watch for that. Also it can't directly identify FCF/share>EPS so I have to do that manually as part of the shortlist process below.

This will return a long-list of stocks (20 or so at the time of writing) which is where the hard-work starts. But to me this next stage is interesting and not particularly time critical so easily done as part of an EOD strategy (in fact I do mine weekly).

The process for the long-listed stocks is then:

i)check the screening data is accurate. For smaller cap stocks anything with only one broker forecast is omitted – there need to be at least two forecasts to give a consensus (and preferably more). In particular I manually check the PEG calculation and that CFPS > EPS (or cash flow > net income) which the screen can’t handle (this is buried in the ‘fundamentals/financials’ tab of the Digital Look companies page, but it is there). I also want the company to have reported EPS and revenue growth over the last three years, and gearing of less than 50% (although less worried about this if cash flow growth is particularly strong).

ii)Director selling over the last six months? I don’t worry too much if just one has off-loaded shares, but if there have been several selling in size then that is a clear warning signal.

iii)I then go into a range of ‘softer’ factors, such as the last outlook statement (is it positively or cautiously worded?), have they given guidance and are broker estimates above or below, I read through the last results statement looking for anything that might be concerning (big working capital swings, etc). This is the most difficult part to describe as its essentially an intuitive process – basically does everything look right?

This then gives you a shortlist, with which I use TA to define entry and stops. This is not particularly sophisticated and anyone with their own favourite set-ups should probably use those (although remember we’re fundamentally buying stocks to hold for weeks / months rather than days). I'm not very sophisticated here - 50 and 200 daily MAs, obvious support and resistance lines. To be clear, I'm looking more at whether the chart is showing a warning signal, and to set a stop level than to finesse an entry. If there is no obvious technical position for a stop within a reasonable distance (relative to perceived risk/reward, but usually about 10%) I will usually scratch the trade. This strict criteria for exits is absolutely critical for any longer term strategy if it is not to end up as a buy, hold and hope plan which is as good a method as any to lose money.

Exiting a position. First, into my diary go all key dates - results, analyst meetings, trading updates etc. On the day of one of these I will always check that i) the fundamentals haven't changed or ii) that the price action isn’t warning me about something. Otherwise each week I check that the metrics for the stock have not materially changed, and that the chart based stop is still relevant. If nothing has changed fundamentally, but strong performance means it falls outside the valuation parameters (ie PE>20 or PEG>1.2 (my warning level)), then I don't sell as momentum may carry the stock much further in defiance of gravity, but instead pay close attention to the charts and sell on any technical weakness – I’ll generally move the stop closer at this stage.

What you should end up with is a reasonably well diversified portfolio of 15-25 stocks which have the various ingredients (value, growth, momentum) to increase steadily in value over time. Most important, and probably where most long-term investors go wrong, is to be strict about exits - not just buy and hold. It’s not the only approach I take in my EOD trading, but is the longest lived and most successful of my portfolio approaches.

For anyone struggling with some of the fundamental metrics mentioned here I would strongly recommend the Jim Slater books which I don’t think are currently in print, but are easily available second-hand off the web.

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The pessimist complains about the wind, the optimist waits for it to change, the realist adjusts the sails.

neil

Excellent post and thanks for taking the time to compile and post. Jim Slater is a good read (showing my age). Do you spread bet these stocks ?

(Another book...cannot recall it now....wrote of a method whereby you keep a watch list of stocks going through phases: Consolidation, rise, more consolidation? and a fall; then repeat)

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neil
Education is an admirable thing but it is well to remember, from time to time, that nothing that is worth knowing can be taught.
(Oscar Wilde)

Jack o'Clubs

Thanks Neil. I tend to buy them outright for two reasons: i) the nature of the screen means that you tend to get mid/smaller caps and apart from IGIndex I'm not sure many of the SB firms cover much of the stuff that comes up and when they do the spreads can be quite wide, and also because I can end up holding stocks for a while (my oldest holding is Chemring, from Dec 07) the roll-over costs can mount up. IG is probably the best bet for trying to spread-bet the system, with their combination of good small cap coverage and quarterly 'single stock futures' type bets rather than daily roll-overs.

Tim - thanks for the rep: try and get hold of the Slater book: well worth reading if fundamentals based analysis is new to you.

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The pessimist complains about the wind, the optimist waits for it to change, the realist adjusts the sails.

timsk

Hi JoC,
Good idea for a thread and excellent opening post.
I confess it's a long time since I've looked at company funnymentals and will have to read up on these to refresh my memory! That said, am I not correct in thinking that growth companies tend not to pay dividends - or only diddly little ones? Perhaps you've included these two filters - which appear to negate one another - as a good way to whittle down the size of your watchlist?

As an aside, I have a (very successful) LTBH friend who is recommending that I beg, borrow and steal every penny that I can lay my grubby little mitts on and plough everything into these two companies: CRA and TCY. I don't want to bump your thread off topic but, equally, if you have time and the inclination I'd be very interested to hear your pro' opinion about them!
Cheers,
Tim.

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Great traders and great comedians share a common skill that underpins their success: they're both experts at TIMING.

Jack o'Clubs

Good point. The reason I do this is that I don't want start-ups / high risk growth: this is focussed on established companies where there is a good probability of the trade working. By insisting on a dividend yield it suggests the companies are sufficiently mature and confident to be returning some cash to shareholders. The dividend is a measure itself - extra 'points' for a company that has increased its DPS year on year. As you say, it also has the effect of reducing the watchlist, which otherwise would be enormous and full of small and micro-caps.

I'll have a look at CRA and TCY when I've got a bit more time and get back to you. CRA looks like a basket case at first glance though - falling revenues, negative margins and cash-flows, rights issues, cyclically exposed... Unless your friend knows of a contract win coming up that the market is unaware of!

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The pessimist complains about the wind, the optimist waits for it to change, the realist adjusts the sails.

timsk

Hi JoC,
Thanks for the clarification.
Re. CRA - it has developed a nifty little device for getting an extra 10% or so (I forget the exact amount) of oil and gas from existing wells which, at the moment, can not otherwise be extracted. This device was due to be tested late last year in Italy, but the Italian equivalent of the HSE stopped the test at the eleventh hour and demanded extra safety measures be put in place. A combination of this set back and the fall in the price of oil resulted in the price of CRA shares waterfalling. However, a new test date is set for the summer and, if the price of oil returns to the levels that most industry pundits think it should (spanish89? - tehe), then CRA could be a ten bagger. Yes, it's a HIGHLY speculative play with lots of 'ifs' and 'buts'. However, I'm of the view that the magic gizmo will work and the test will be successful, not least because the R&D has been funded by the industry itself - in fact, by some of the end users who will become Corac's customers. If they think it will work, who am I to disagree?
Remember folks - you heard it here first!
Tim.

__________________
Great traders and great comedians share a common skill that underpins their success: they're both experts at TIMING.

Jack o'Clubs

Ah - CRA, it's one of those - a 'story'

Given the provisos you've listed above, then if you're absolutely convinced by the technology story and that someone else hasn't got a widget that will save 15%, and the IP doesn't revert to the industry backers if it fails (and therefore might have an interest in it not surviving), then yes it might be worth a few quid on the basis that it will probably go to zero, but you might end up with a ten-bagger. A bit like backing an outsider at the Grand National... But that's a bit different from the opening salvo that this was a stock to beg, borrow and steal and then plough everything in to! My view is that the equity gets run down to zero and then ENI buy it for a song - time will tell.

TCY looks a bit more interesting - good business model, beating street estimates at last results, solid order book, confident of 09 outlook, decent financials. Yes, I'd be happy to buy this one. I don't quite see why it's a 'bet the ranch' job, looks more like a solid plugger - the mix of growth and defensiveness is particularly attractive at the current time.

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The pessimist complains about the wind, the optimist waits for it to change, the realist adjusts the sails.

timsk

Hi JoC,
Neither stock is a 'bet the ranch' job, that was a little exageration on my part to make the post marginally more interesting! Thanks for looking over them both for me, I appreciate the feedback.

Tim.

__________________
Great traders and great comedians share a common skill that underpins their success: they're both experts at TIMING.