10 Keys to Finding the Biggest Winners Over the years I have learned a lot about the do’s and don’ts of stock trading. Here is my short-list of what I have found most effective for finding those big winners. For more on my trading methods and how I turned the proceeds of the sale of my car into $42 million in under two years, please see the links to the first article and my media library in the Resources section below. 1) Pattern Presence. Once of the best ways of finding companies with strong momentum capability is to look at its chart. Chart patterns will tell the trader whether the stock is walking the fundamental walk and if market is recognizing this. I need to see a stock show good price action such as holding support and breaking resistance on increasing volume. Some of the most powerful patterns include three of my favorites – bullish Flag and Pennant continuation patterns and the Cup and Handle continuation pattern, all of which are consolidation (as opposed to reversal) patterns. An essential book that every trader should own is Thomas Bulkowski’s Encyclopedia of Chart Patterns (2nd Ed) published by John Wiley & Sons. Bullish patterns are an indication of institutional accumulation. 
Chart 1 – Daily chart of Baidu.com showing examples of a cup and handle (arrows) and flag pattern (far right). Chart courtesy www.ChartPattern.com 2) Volume Confirmation. Patterns by themselves do not tell the whole story about what is happening with a stock. The proactive investor or trader looks for volume confirmation. Volume is the true indication of what market players are doing for those who know how to read it. During extended periods of consolidation, patterns like Rounding Bottoms and Cup and Handles are good indications that a move is imminent. Volume provides the confirmation that buyers are stepping in to buy in a rally and that selling is picking up in a correction. Are traders buying dips or selling rallies? The first is bullish and is recognized by volume spikes following weakness or after a prolonged down move. The second is bearish especially if volume builds on price declines after an extended up move and means either shorts are capitulating and covering or ‘Johnny-come-latelys’ are jumping on board. If volume increases as the stock drops, it means that the smart money is using rallies to unload and the shorts borrowing to sell the stock short. When this happens the elevator ride is usually over. Bullish continuation patterns should show volume dropping as the pattern forms with volume spikes on the breakout. If there is no spike, the breakout must be considered suspect. 
Chart 2 – This chart of Netflix shows what I mean by volume confirmation. Notice that on strong up moves volume increases and then decreases during consolidations. Can you spot the larger and smaller flag patterns? (Hint: They are consolidation patterns). Chart courtesy www.ChartPattern.com 3) Market Direction. As they say, a rising tide lifts all boats. Warren Buffet described what happens in a falling market best when he said, “It’s only when the tide goes out that you discover who is swimming naked.” Since 60-70% of a stock move is determined by the overall direction of the market, it is important to trade stocks that are following the overall trend. Methods for do this include an analysis of advancers minus decliners, waiting for an index trend line break or moving average crossover. An even better way however, is following the leaders of the market. But no matter how strong a stock is, it will be fighting an uphill battle in a bear market. Look for strong stocks to buy in a bull market and the weak laggards to short in a bear. 4) Leadership. This brings us to our next point. Let the leaders show you when to go long and when to go short. There are times to buy and times to sell and market leaders provide advance warning that a reversal may be imminent. If the leaders begin to break down even in the face of good fundamentals, the market is probably not far behind. Once the market has turned, even a leader cannot fight the gravitational pull for long. No point in trying to trade or invest counter to the primary trend. When the market is going up, leaders will keep you in the trend and when the market reverses and heads down, they’ll tell you when to sell and when it’s time to look for laggards to short. Never marry a belief, a stock or the market. I outline the markets leaders daily in The Zanger Report. 
Chart 3 – My market leaders table showing the stocks I was following on March 23, 2009 two weeks after the rally began. Notice that these stocks are making big moves on big volume and were moving ahead of the market. 5) Support/Resistance. In a rally, support levels should be continually built upon. Bullish continuation patterns provide further evidence that a rally is underway. In a true bull rally, I like to see a number of bullish Flag and Pennant patterns as well as upside gaps. But when support levels get broken and resistance levels on upside moves hold look out. Another sign of trouble is when breakouts happen on less volume than the prior breakout or gaps begin to get filled. This means the move is running out of gas. Sentiment can also be helpful. In a rally, stocks discount bad news. In a bear, they discount or ignore good news. Bad news, good action = bull. Good news, bad action = bear. Drawing trendlines as well as support and resistance are some of the most basic technical tools employed by successful traders and money managers. Never question a trendline or support break. When a break occurs, it’s best to exit your long position and wait for confirmation. Is the weakness is the beginning of a reversal or just a short-term consolidation? 
Chart 4 – Daily chart of Wynn Resorts showing both support and resistance lines. Once support is broken it becomes resistance, and resistance broken becomes support as we see at the right-hand side of this chart. Chart courtesy www.ChartPattern.com 6) Earnings Power. This brings us to the most important fundamental consideration. To be a market leader a stock needs earnings power and plenty of it. Look for companies with earning up over 70% or more in the most recent quarter and where earnings growth has accelerated during the past 2 to 4 quarters earnings. Most of the big movers have earnings up 150 to 400% quarter over quarter. Stocks such as Taser Inc. (TASR) that made a more than 5000% percent move in 2003 and 2004 while earnings and revenue growth exceeded 200% or more each and every quarter for around 6 quarters. Another big mover that started in April 2003 and had similar earnings growth was Research in Motion (RIMM). Apple and Google are modern-day examples. 7) Market Dominance. Market monsters are stocks that are dominant powerhouses – top dogs – in their respective industries. Here are some examples. Qualcomm (QCOM) went from $225 to $800 (pre-split) in just 6 weeks and Yahoo went from $80 to $400 (pre-split) in just 3 months in 1998 before GOOG was on the scene. Others include CMGI (a big mover during the internet bubble and made a move of over 6000% in 20 months) and DELL that went from $50 to $2000 (pre-splits) over a 3-year time frame. All of these companies dominated their industries. DELL another leader, changed the way computer products were marketed, carried a small “just-in-time” inventory, in home warranty service and the fastest computers of the day. This combination crushed competitors Compact and Gateway and in so doing made its shareholders rich. Market domination is the most overlooked aspect of selecting big winners in the market. Again, Apple and Google are more recent examples. 8) New Stocks, New Markets. It is important to find stocks that are new or relatively new to the market or that have new products that are gaining widespread acceptance not only in the U.S., but also in most of the developed and emerging markets. Companies like GOOG are known and its products used all around the globe. Another good example these days is Apple Computer (AAPL) thanks in a large part to the introduction of great ground-breaking products like the iPhone and iPad. 9) Under Known and Under-Owned. The total number of shares that the public can buy is known as the float. Ideally, there should be less than 100 million shares in the float. Stocks that have a limited number of shares in the pubic float have the potential to experience explosive moves once they are discovered due to the small share supply. Taser (TASR) was good example of this a few years ago. It started out with a float of just 3 million shares and now has a float of 57.2 million due to numerous stock splits. The stock price went ballistic in the process. Find stocks that institutions are beginning to accumulate and the stock will experience a powerful lift as the pros build positions. This includes those with a higher degree of corporate executive insider ownership. 10) Seasons and Cycles Etc. Other useful tools for finding the best entries and exits include trend lines, moving averages, the McClellan Oscillator, seasonal cycles and time cycles are examples. Look at the daily chart over a nine to twelve month period. Do you see rhythmic dips and seasonal patterns? Did you know that the 4-year Election Cycle is the most powerful short-term pattern in markets? Resource and commodity stocks often exhibit distinct seasonal patterns based on growth and market cycles. Another important consideration is price. Cheap stocks rarely lead. Although there are some exceptions, it’s best to wait till they are over $50 and of greater interest to institutions. Resources: Chart Patterns, Trading and Dan Zanger – Stocks & Commodities magazine https://docs.google.com/viewer?url=http://www.chartpattern.com/cf/images/new/articles/stocks-comm-2003.pdf&pli=1 Understanding Chart Patterns http://www.chartpattern.com/understanding_chart_patterns.html Dan Zanger’s 10 Golden Stock Trading Rules http://www.chartpattern.com/10_golden_rules.html Dan Zanger’s Media Library http://chartpattern.com/media.html The Zanger Report http://www.chartpattern.com/cf/registration_form.cfm Recommended Reading: The Encyclopedia of Chart Patterns by Thomas Bulkowski http://www.amazon.com/Encyclopedia-Chart-Patterns-Wiley-Trading/dp/0471668265/ref=sr_1_1?s=gateway&ie=UTF8&qid=1284754800&sr=8-1 |
