Stock Pick (Google Part 3)
3. Exit Point
Fundamentals
- I will sell Google when its fundamentals has deteriorated like decline in cash flow and also when, I am no longer optimistic on its growth. I will compare the quarterly result against the previous quarters and also the annual result too .. Will probably come up with a list similar to the one I did for entry to decide again. (This will be an exception whereby I will sell off the stock without adhering to my below stop trail set),
- I will also sell Google if its relative valuation like (P/E , P/S) has ballooned excessively.
Momentum
1. Relative Strength
Weaker 3, 6 and 12 month relative strength.. Anything below 50 will be considered weak
2. On Balance Volume
OBV is downward sloping
3. ADX
Anything between 13 and 14 indicates a weak trend
4. Moving Averages
When Occurrences of fast moving averages go below the slow moving average.
5. Trend
- Parabolic move is fully developed (three or more success trend lines)
- Stock price is near vertical
I will asses the above factors weekly and if there's a need, I will consider to sell the stock even when the current price is higher than my pre defined stop loss trail.
Reproduced with permission from http://melynn-lynch.blogspot.com
Stock Pick (Google Part 2)
Momentum - 3/4
Total of 10 points : 7/10
I will only enter f the total points is more than 5.
I will be using a 50d ATR to estimate the volatile and it is currently at 15.137. Below are the steps I need to take to derive the position.
- Determine the amount of money in account
Assuming I have $25 000
- Determine the amount to risk
For a start, i will set a 2% risk.
- Find out the ATR
Multiply ATR by 2(static)
15.01* 2 = 30.02
- Derive the position by taking amount to risk divide by the above sum
500 / 30.02 = 16.65 shares
~~ 17 shares.
3 factor model (Volatility)
The position size of each trade I take will be based on volatility and the indicator which I will use to measure is ATR.
ATR is the difference between the high and low price on any given day. It reveals information about how volatile a stock is. Large ranges indicate high volatility and small ranges indicate low volatility
One weakness of using this strategy to determine stop loss is that it might cause my system to be susceptible to noise resulting in unnecessary brokerage costs incurred. To overcome it, all 3 factors which I discussed earlier has to be implemented together..
3 factor model (Momentum)
I don't really know much on this area yet so if anyone happened to come across this blog, please feel free to comment on it or contribute.
As of now, following are the indicators which I used to check the stock's momentum .
1. Relative Strength
Relative strength, or RS, measures how a stock has performed compared to the overall market over a specified time frame. This info is only easily accessible for US markets.
Six-month relative strength >= 75.
Three-month relative strength >= 65.
For example, a 6 -month relative strength of 75 means that a stock has outperformed 75% of all stocks, in terms of price performance, over the past 6 months.
2. On Balance Volume
OBV attempts to detect when a financial instrument (stock, bond, etc.) is being accumulated by a large number of buyers or sold by many sellers. Traders will use an upward sloping OBV to confirm an uptrend, while a downward sloping OBV is used to confirm a downtrend. Finding a downward sloping OBV while the price of an asset is trending upward can be used to suggest that the "smart" traders are starting to exit their positions and that a shift in trend may be coming. (By investopedia)
If the OBV is moving in the same direction as the existing trend, it is a signal that the strength of the trend remains. When the OBV starts to move against the trend, it is a signal that the existing trend is weakening and may reverse.
3. ADX
Analysis of
A low ADX value (generally less than 20) can indicate a non-trending market with low volumes; a cross above 20, on the other hand, may indicate the start of a trend (either up or down). If the ADX is over 40 and begins to fall, it can indicate the slowdown of a current trend. This indicator can also be used to identify non-trending markets or a deterioration of an ongoing trend. Although market direction is important in its calculation, the ADX is not a directional indicator.
4. Moving Averages
Occurrences of fast moving averages crossing over the slow moving average is a bullish signal while the vice versa is a bearish.Current moving average I'm using is 14,25 and 200
Pitfalls of Momentum Trading
Here they are:
Based on the above, i personally think momentum has to be done in moderation cos I never want to be the last one holding on to it therefore for my future trades, I will try not hold on to it based on greed (Not willing to profit early) or fear (Not willing to cut loss). Reproduced with permission from http://melynn-lynch.blogspot.com |
3 factor model (Fundamentals)
My entry/sell point is currently based on the following 3 factors Fundamental, Momentum and Volatility. I will be doing trial and error to adjust the weightage of each factors but for a start, I will allocate more weight to fundamentals.
For fundamentals, it will be categorized into 2 section, valuation and operating history. For operating history, I will use both quantitative and qualititave analysis to assess the company's management, financial health, profitability and cash flow.
For valuation, I will use p/cf , p/b, p/e, p/s and compared them against other similar industry competitors or the company's own 5 year historical average. One thing to take note is that companies with low ratios might be value traps and it may take years for the market to find this value and the stock can stay priced at these undervalued levels for extended periods, resulting in opportunity cost incurred as capital will be tied up on the stock.
Therefore to mitigate the risk of value investing, I will add a momentum filter to improve returns by avoiding the problem of waiting for the market to recognize the undervaluation. This will be discussed in the next section.
Not too sure if the above has already been mentioned before in my previous posts but the most significant change which I am making to my current system is to use relative valuation instead of absolute.
Have gotten my inspiration from investopedia .
Reproduced with permission from http://melynn-lynch.blogspot.com
Thoughts on valuation
I have decided to abolish the use of forecast values as one of my entry criteria after giving some thought reason being :
1) Future is uncertain. The model requires one to project most of the inputs much ahead (like 5,10 years) which is not realistic in my opinion.
2) Tendency to use them to reinforce my decision when faced with uncertainty regardless of its relevancy.
Therefore instead of relying on forecasts, I will value the stock based on real results(i.e trailing p.e) even though this only tells me what the stock "should" have been worth based on earnings from the past . This is a trade off I'm taking but I believe the risk of relying on my own forecasts is much more dangerous.
Melynn - Philosophy on investing part 6
I have mentioned on the theory of reflexity in my previous posts and even though I have yet to grasp hold of the concept but just the initial understanding has already intrigued me to find out more. I did an extensive search on the net and found an article discussing on this..
This concept is founded by Soros and he attempted to explain his concept of reflexity in the following statement :
"There is an active relationship between thinking and reality, as well as the passive one which is the only one recognized by natural science and, by way of false analogy, also by economic theory. I call the passive relationship the “cognitive function” and the active relationship the “participating function,” and the interaction between the two functions I call “reflexivity.” Reflexivity is, in effect, a two-way feedback mechanism in which reality helps shape the participants’ thinking and the participants’ thinking helps shape reality in an unending process…”
Example (Extracted from the article)
Consider the relationship between a company and its publicly traded stock under normal business conditions. It is intuitive that when the fundamentals improve the share price rises. However, does it make sense that a changing share price might, in turn, impact the fundamentals? Sometimes the answer is yes.
A simple and timely example is seen from the effect of credit ratings. When Moody’s or S&P downgrades the credit ratings of a given financial institution (think AIG), it can have an impact on the amount of collateral the company must pledge to back its obligations. A downgrade also increases the cost of capital for new debt issuances. The view of the S&P analyst is, in part, subjective. The perception of the company’s future prospects and current financial condition plays an important role in the assignment of the credit rating, and and a falling stock price gives a bad impression. The negative feedback loop between capital requirements (fundamentals), stock price, and credit ratings (perception) causes a vicious cycle.
Common to all recessions are forces that cause dynamic disequilibrium between fundamentals and prices.
Some of these are,
A. Jobs losses --> declining consumer spending/confidence --> contraction in businesses targeting consumers --> more job losses due to business contraction, etc.
B. Credit crunches: Business and consumer balance sheets deteriorate --> tighter lending standards and less credit available --> business/consumer spending slowdown --> worsening balance sheets, etc.
C. Stock market declines --> reduced “wealth effect” --> decline in consumer spending --> business contraction --> more stock market declines, etc.
D. Stock market declines --> lower capital gains tax revenues --> rising government deficits --> decreasing investor sentiment -- > more stock market declines, etc.
Details can be found here
His ideology is often mistaken as trend following but one contrasting difference is that he always managed to enter/exit at the reversal point so from this, I gather a clue. I need to come up with an objective view by looking at a bigger picture and in order to do that, I must constantly remind myself not to be distracted/mislead by the daily reports and news.
Reproduced with permission from http://melynn-lynch.blogspot.com
