How to Begin Your Search for Quality Trades
Generating consistent returns is nearly impossible if you fail to understand where you should be concentrating your time and energy.
Trading can be a tedious process if you don’t first use a top-down approach to finding the most promising names on the market. Imagine logging onto your computer every night and combing through the charts of every one of the 6,000-plus stocks that trade on a U.S exchange. I doubt it would leave you much time to eat or sleep — and you still might not find the best place for your trading dollars.
So instead of blindly chasing random stocks, you should take the time to uncover the market’s strongest trends. From there, you need to find the best way to exploit them for trading profits.
Today, I’m going to walk you through a simplified approach you can use to narrow down your potential trading opportunities (I recommend using a top-down approach like this one every couple of weeks to ensure you’re staying on track). Over the next few weeks, I’ll continue to add different ideas to the mix, much like I’m doing with my stock screening tips. Using your feedback and suggestions, you will eventually have a thorough reference guide that you can add to your trading toolbox.
First, let’s start our top-down approach with a look at the broad market.
Overall, stocks are having a banner year. The S&P 500 is up more than 15% year to date, while the Nadaq Composite is up almost 20%. That is as simple as it gets. But of course, it’s not enough information to guide our trading decisions.
On the surface, you might think the Nasdaq’s outperformance is enough reason to toss your money at speculative tech names. But don’t let this performance fool you into thinking that smaller names had a major hand in the index’s rise. Mega-cap technology names — specifically Apple Inc. — are responsible for the Nasdaq’s spectacular run this year.
In fact, a little digging shows that bigger stocks are the place to be right now:
Here’s a chart of the S&P 500 compared with the Russell 2000 — our preferred small-cap index. Notice how the Russell has lagged the S&P during its recent surge higher. The market is telling us that bigger is better right now…
From here, we need to identify what large-cap stocks could offer us an edge. Mega-caps might be a good place to start. With the Dow again nearing 52-week highs, you’ll quickly find that many of its components have posted solid returns so far this year.
Just look at Home Depot (NYSE: HD):
Alert readers will remember that we’ve been tracking this home improvement giant’s performance since late 2011. It even made it into my list of 2012 predictions as a potential new market leader.
Home Depot isn’t the only consumer name that’s outperforming the broad market right now. In fact, consumer stocks have continued to lead stocks higher since the start of the June uptrend. Here is the Consumer Staples SPDR versus the S&P 500:
If we stick to large-cap consumer names for this search, we quickly find this Wal-Mart (NYSE: WMT) chart:
Wal-Mart is up 26% on the year. The stock has consolidated between $72-75 since late July — and it appears to be attacking reistance this week. Judging by this bullish chart, it could have another run in it…
As you can see, a top-down look at the market can quickly and easily yield intriguing trading ideas like this one. I’ll continue to walk you through idea-generation techniques like this one every so often in these pages — and I recommend you develop your own versions of my top-down approach, too.
Greg Guenthner, CMT
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