A Simple Process for Finding Stock Ideas

I have seen or heard it so many times. I have committed the offense myself on numerous occasions. It usually leads us to make quick, rash, emotionally driven decisions to the detriment of our portfolios. What is this offense? Trading on the news, the latest tweet or the hot tip from your brother-in-law who has been absolutely killing it in the market for the past year (his words with no proof offered).

We have all been there. Our emotions have a tight grip on us and drive our actions. But when it comes to trading and investing, our emotions are our worst enemy. This is especially true when markets are volatile as they have been for the past 18 months. We hear about the big swings in the market and we have an urge to check our portfolios. If the market has rallied we may think about selling some positions to “lock in” profits because we don’t want to give any back. If the market has had a sharp selloff, we may become nervous, we may start thinking about how much more we can lose and decide to sell everything and “move to cash” because hey, you heard on CNBC that that is what all the big fund managers are doing.

If you were investing in 2009, be honest with yourself…how did you feel in March of that year? Were you backing up the truck to add equities to your portfolio? Or were you becoming panicked? Were you watching your retirement account continue to decline and were you wondering when the bleeding would stop. Were you glued to the TV or the internet? If you were, the news was most certainly doom and gloom making it more likely that you would have sold at the absolute worst time.  

Now I recognize that there are many different types of investors with different goals and time frames. For the investor who is saving and investing for retirement, this post will not apply to you. You are presumably working with an advisor who has helped construct a plan so that you can reach your goals and that’s great. I would argue that for that portion of your portfolio (or maybe it is your entire portfolio), you should look at it rarely and make changes to it even less often than that. Resist the urge to utilize easy access to technology in order to check your portfolio every day. In fact, from a behavioral perspective, the less frequently you check your portfolio, the better off you may be. This is due to a behavioral phenomenon known as loss aversion. We tend to have a greater sensitivity to losses than to gains. Investors who evaluate their portfolios less often will usually be willing to accept the risks of investing.

For the more active trader/investor, if you are going to check your portfolio daily or even multiple times a day, you need a way to combat loss aversion. You need a way to filter through the noise and find the signal in the market. The media is the noise, Twitter is the noise and your brother-in-law is the noise. You need a simple, repeatable process.

Over the past year, I have honed my process to the point where it can be summed up in one sentence: Buy Bullish stocks with strong money flow and relative strength from leading industry groups when those stocks are oversold.

The process starts at the top and then moves down to the stock selection stage. The process can be used regardless of the market environment. The process is simple and it is repeatable.

At Chaikin Analytics, we track 21 industry groups within the S&P 500 to get a sense for which areas of the market are outperforming and which are underperforming. We can do this simply by sorting the different industry ETFs based on their performance over a certain time frame. In this case we will use three-months. Using the ETF Comparison Tool in Chaikin Analytics, we can see the industries which have been leading the SPY.

We can also see which of these ETFs has a Bullish for Very Bullish Chaikin Power Gauge ETF Rating.

Next, we want to know which of these trends are most likely to continue into the future. We do not have a crystal ball and we can’t predict anything with a high degree of certainty over long periods of time. However, we can use tools to help us put the odds in our favor. The Power Bar tells us how many stocks in the funds have Bullish, Neutral and Bearish Chaikin Power Gauge Rating. The stronger the ratio, the more likely that industry is to outperform the broader market.

The Insurance industry has the second best performance over the past three months (you can change the look back to fit your timeframe), has a Very Bullish Chaikin Power Gauge ETF Rating and a Power Bar Ratio of 31 to 2, Bulls to Bears. This is a clearly a leading industry group.

Now, which stocks should we look at in the insurance industry? There are 117 from which to choose. I used the Screener in Chaikin Analytics to find the stocks which meet the criteria in my one-sentence process to quickly narrow the field. Bullish Rating, Strong Money Flow, Strong Relative Strength, Oversold.

We now have two stocks for consideration. Progressive Corp. (PGR) was the stock of the week in my latest Market Survival Guide. We can quickly see that all of the criteria are met and that the stock is in a clear uptrend. 

Renaissancere (RNR) is also a compelling name based on the criteria that I have laid out. 

The process that we used to find these two names was done without the consideration of anything that was not material to the decision. We did not have to sift through news stories to find something bullish about insurance and we certainly did not need our brother-inlaw to give us an idea. We used a simple process to make an investment decision based on facts as they are; not how we wish them to be. And now we are less likely to panic and sell too soon based on the next headline or tweet.

Once we have identified stocks to buy, risk management becomes extremely important and we will cover that in the next post.

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