How to Pick Stocks |
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by J. C. (Chris) Pratsch |
...hard- and software, but less about day-by-day application of this technology.
Therefore I will concentrate here on an answer to the often-heard question in our HAL-PC Investment SIGs: "How does one pick a stock with the computer?" I assume a most-important addition "a stock that will go up in price" is the actual central part of this problem.
There are two answers: The first is, that I don't know the full answer myself, otherwise I would not write this article but, rather, sit on a nice beach and just count my money. The second answer is complex: A good stock is a healthy stock in a healthy environment. It is not the computer or computer software that is of primary importance.
You do not need a fancy, fast computer either; a simple one will suffice.
There are about a dozen good computer programs on the market. It depends only on your skill, degree of involvement and experience to determine which one to select. Compared to the underlying market and financial potential, your computer is cheap.
A healthy financial environment includes a healthy industry with increasing or at least stable income, falling Federal fund rates, low inflation, an over-all rising market, a strong dollar etc. Look into the newspapers and listen to news!
Financial health of a stock is measured in parameters obtained from fundamental economic-financial research. Often it is expressed (if we want just a few parameters) as P/E (price/earnings) ratio, positive cash flow, dividends etc. P/Es are published in company reports, newspapers, or in down-loaded data bases. Healthy P/E ratios do not promise short-term high prices, though; they rather promise long-term healthy price levels. The computer may help us in this initial stock-selection by identifying prices lying above much-used 200-day or 48-months price averages and showing generally "up" price curves.
Financial health of an individual stock is indicated by a price curve that, in its over-all upwards tendency, shows consecutive lows that are higher most of the time. Do not buy into a falling trend!
Another important parameter of the financial strength of a stock is its volume behavior. This is indicated in computer programs by daily volume, volume averages, proprietary computer-based indicators like Word's TC-2000 Money Stream and BOP-(Balance of Power), and by the commonly found OBV (On-Balance-Volume). It shows daily a new point on a cumulative curve giving the difference between purchase and sale volume per day, defined by the closing price of a particular stock. The volume direction and amount indicates the interest of the market in a particular stock. Increasing OBV values indicate more buying, hence a tendency to push the price up. Decreasing OBV values indicate less buying or selling, hence a tendency to push the price down.
Other computer-furnished indicators are price averages or price/time ratios, also called oscillators (RSI, stochastics), or price/volume ratios (RSV). One can easily define a certain price average curve as indicator for our market actions: If the price is above the average, buy or hold; if it is below the average, sell or hold. The price average that we pick determines our investment approach. It is a good sign of our individual philosophies.
Computer scanning programs identify stocks in the data base that incorporate the main financial parameters selected on the base of price behavior and our own financial philosophies (like price averages, volume development, stochastic levels, net price increase etc).
There are probably a hundred or so individual indicators in the field. Some computer programs contain most, others just a few. All indicators, however, have one thing in common: They can only combine past price, time, and volume. They describe what has happened to the price in the past (up, down, fast, slow) and generate a curve showing the price history. It is up to us and our knowledge to extend these historical curves into the future. There is no predictive computer or any other approach.
Some investors use cyclic or rhythmic price behavior as price prediction techniques: Certain stock prices move in 1, 2, 3, 4 or higher months multiples. These changes are tied to market conditions, product acceptance, financial dates, dividend payments and other factors. Rhythmic price changes demand that some parameter(s) vary while others stay constant or are minor. Often outside or inside conditions change, and the rhythm changes, disappears, or re-emerges at a different frequency. Dividend-payment related price variations are most common but with few exceptions do not amount to much. They are commonly eliminated by commission costs when we trade for them. Some, however, like weather-related price changes in the energy industry, or the 4-year US Presidential Election-related cycles, are worth serious considerations.
Here then is a list of steps one should take to reach the goal: to pick a promising stock.
1) Establish your target, risk, level, timing requirements etc.
2) Define the outside financial environment for yourself (world, country, industry, individual stock).
3) Select financially healthy stocks (with positive P/E development, low P/E, indication of earnings increase or stability, dividends, positive price trend, established positive price history).
4) Determine your own indicator values and levels.
a) Price and price averages ("trend indicators" like price averages or MACD).
b) Price development ("oscillators" like RSI, stochastics).
c) Volume development (like volume, volume averages, OBV, RSV).
5) Select the stock(s) that incorporate all or most of these considerations, but be prepared to sell as soon as any one of the critical parameters is violated beyond the limits you decided in the beginning: Price direction, or price drop beyond certain pre-set limits in $ or in price %, change in overall financial environmental considerations etc. This is a wide field of personal decision and individual financial planning. For example, long-term holding or short-term trading are two opposed techniques that demand different philosophies and approaches. They are tied to a distinct person or program: What I call safe you may call risky, when I sell you may hold etc.
Once you have successfully settled in a certain investment niche and your stocks have done what you expected them to do you can define the critical parameters and build a meaningful computer scanning program: This allows you to use the computer to select from your data base all stocks (or bonds) that fit these preset criteria. In this way you constantly improve your (stock input) data base.
This all sounds, and is, easy. The complications arise with the constantly changing basic conditions, like world affairs, dollar value changes, inflation scares, financial manipulations, and financial-market hysterias. They demand access to a low-cost market outlet with a minimum of commission cost. Which ones? The world is full of them. Unless, of course, you selected in the beginning to be a long-time investor in which case selling and buying becomes probably something of an annual or even rarer ritual.
I still have not said which stock is good today? Well, this depends on...?? Can a computer help in stock selection? Yes, but one must compare and analyze. To do this in a reasonable amount of time demands the help of computer technology.
HAL-PC's various investment SIGs are ideal places to discuss these questions and obtain answers in detail.
J. C. ("Chris") Pratsch is a HAL-PC member and Consulting Petroleum Geologist and has been involved in different modes of private investing since 1966.
E-mail me at webmaster@hal-pc.org with any comments you have and tell me what you want to see here.
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