Good opportunities in active trading

By R&D Manager Geir Linløkken, 11th June 2009.

Keywords: Finance, technical analysis, high risk portfolio, trading strategy

Contents

• Deep fall gives high target
• Composition of the Trader Portfolios
• Return for 2003 and so far this year
• Characteristics of portfolio stocks in 2003 and to date in 2009
• Analysis of today’s situation
• Strategy in today's market
• Tools

Deep fall gives high target

The last two years have seen turbulence on the stock exchange. Most of the world’s stock exchanges have fallen significantly, and this winter they were down between 45 and 65 per cent since the top in 2007. The fear and greed of the investors drive the market and cause overreactions both when falling and rising again, and pushed the market a little extra on the way down. The market tends to rise a lot when a reversal occurs, providing very good trading opportunities.

As described previously in the report "Trading strategy in today’s market", Investtech’s Trader Portfolio gave very strong returns in 2003, which was the last time the market rose after a long fall. Successful criteria at the time were going for a limited number of stocks with technical indicators that pointed to an imminent reversal or which had already triggered buy signals based on price formations, support and resistance and volume development. In addition, insider trading analysis was used to find stocks where key personnel in the companies indicated fate in the fundamental development.

After the recent rise in the market, it appears we are past the bottom for now. The situation is much like the one in 2003. In this report, we look at how Investtech’s Trader Portfolios for Norway and Sweden have performed so far this year, and describe a strategy we believe will give good results in the time ahead. The report will be valuable assistance for traders who wish to use an active strategy based on technical analysis and supported by Investtech’s services.
The report is based on results from Norway and Sweden, but the conclusions are valid in general for all markets where Investtech delivers analyses.

Composition of the Trader Portfolios

Investtech has Trader Portfolios for Norway and Sweden. The Trader Portfolios are made for active traders who seek high return and high risk.

The portfolios are made up of the stocks that Investtech's analysts find to have the best target in the short term. Stocks are picked that have triggered buy signals and are technically positive, but also stocks that are consolidating or have fallen unreasonably much, where volume development, RSI or insider trades indicate an imminent reversal. The portfolio generally buys stocks early while taking gains relatively quickly and losses very quickly. High risks are taken, especially when the total market is assessed as positive.

The Trader Portfolios are updated once a week, before the stock exchange opens on Fridays in Norway and Wednesdays in Sweden. Investtech's analysts thoroughly assess the market, looking for good buys. The most important tools are Top50 based on Overall Analysis, Insider Trades and Trading Opportunities. In addition, Signals and the last ten Daily Cases are considered.

The portfolios normally consist of 5-6 stocks. On average each stock has a holding time of approximately two weeks. The strategy is the same now as it was for the Norwegian Trader Portfolio in 2003.

The Trader Portfolios are models of how Investtech's systems can be utilized in active trading. It can be difficult to follow the models directly, and active traders might want to make daily assessments of the market and perhaps trade even more often than the models suggest. The Trader Portfolios should first and foremost be seen as an example and an inspiration to learn how to use the tools and methods behind the model.

Return for 2003 and so far this year

Last time the stock exchange reversed after a long fall, was in 2003. The Norwegian index rose by 48 % that year, and the Swedish OMX Stockholm PI by 30 %. The situation now is much like the one in 2003. The stock exchange fell deep last year, but has reversed. There are technical buy signals and insiders are positive.

Return for the Norwegian Trader Portfolio for 2003 can be found in the report Trading strategy in today’s market from November 3rd 2008. The portfolio that year gave a return of 302 % after 0.2 % commission per trade. This was achieved by trading a total of 136 stocks. Each stock was in the portfolio for an average of 9 days and gave a return of 6.21 % after commission.

As of April 30th, the Swedish Trader Portfolio has given return after commission of 74 %. This is 58 percentage points above OMX Stockholm PI. The Norwegian Trader Portfolio has given a return of 20 % after commission. This is 8 percentage points above index. Average return per investment was 9.09 % for Sweden and 3.76 % for Norway.

The charts show return before commission for the Trader Portfolios in Stockholm and Oslo from January 1st to April 30th this year.

The good development appears to continue in May, with total return after commission as of May 7th of 84 % and 35 % for Sweden and Norway respectively.

Characteristics of portfolio stocks in 2003 and to date in 2009

Details for the stocks in the Trader Portfolio are here (pdf-file of 140 pages, 6MB). Details of the stocks in the Trader Portfolio from January to April 2009 for the Swedish OMX Stockholm PI are here (pdf-file, 1.8MB) and for the Oslo Stock Exchange here (pdf-file, 1.4MB). The files contain details of all stocks that were in the portfolios in the relevant time periods, including short term and medium term charts, insider trades and candle sticks. The price graphs in the charts are in blue for the period of time when the stock was included in the portfolio.

Below is a description of the characteristics of the portfolio stocks from 2003. The strategy used in 2009 is the same as the one we used in 2003, so the observations are also valid for the portfolios in 2009. Examples are from 2009.

Active stockpicking: The first thing we notice is that the portfolio is explicitly short-term. Each stock was in the portfolio for 9 days on average in 2003, while they have been in for approximately 14 days so far this year. The portfolio has consistently been seeking the "very best" stocks and thus sold stocks that were positive if expected return on other stocks was higher.

High volatility risk: Next we see that the risk of the portfolio stocks was high. Many of the stocks had an annual volatility of over 100 %, while the median value was 63 %.

A lot of small and medium cap: There was a mix of small, medium and big cap companies in the portfolio. The main focus however was on small and medium cap. In 2003 the median value for daily turnover was NOK 2.8m when the companies were included in the portfolio and NOK 3.8m when they were removed.

Positive insiders: Most of the stocks that were included in the portfolio were positive on insider trades when they were bought, especially early in the year. Some were sold after the insiders sold, but a majority were still positive on insider trades when they were sold.

Positive volume development: Almost all the stocks had positive volume development when they were bought into the portfolio. It could be that they fell back on low volume or rose on high volume. It could also be that they had high turnover close to earlier peaks in the price chart, while they had low turnover on the bottoms. BIRD is a good example of a stock like this.
Examples from 2009: BOL, QEC.

Buy signal from formation: Many stocks were bought after they had triggered buy signals from formations in the short term charts, for instance NHY. These are seen as reliable signals, especially if the price reacts back following the buy signal while the volume development is positive.
Examples from 2009: GUNN, ASC.

Price close to trend floor: A few months after the stock exchange hit bottom, rising trend channels were formed for many of the stocks in the short term charts. Many of the portfolio stocks were bought when the price was close to trend floor in these, as this indicates a further rise. Example ACTA.
Examples from 2009: NEO, FUNCOM.

Price close to support: Some stocks were bought when they had been close to support either in the medium term or the long term chart. Early on this was a dangerous strategy, as a break down would trigger a sell signal and consequently often a loss. However, this was often a very good strategy after the rising market expanded and optimism increased. An example is EXPERT.
Examples from 2009: NOBI, BOL, EMS.

Break up through resistance: In the second half of 2003, prices had risen to resistance levels from previous trading. Breaks through resistance trigger buy signals. The stock was often bought into the Trader Portfolio particularly when the buy signals were given on increasing volume. Some of the best investments were made on exactly this criterion, for instance STB.
Examples from 2009: MICR, AUSS.

The portfolio stocks in 2003, and the ones we have included in the Trader Portfolios so far in 2009, were technically positive and positive on insider trades. This was especially true for the short term charts. Volume development and candlestick charts, support levels, breaks through resistance and signals from price formations were emphasized.

The best stocks were bought, and this decided which stocks were sold (unlike a stock being kept for as long as it is technically positive, which is common in the ordinary model portfolios).

Analysis of today’s situation

When we reviewed the Trader Portfolio in November last year, we noticed that the situation seemed quite similar to the one of the winter of 2003. We decided to continue the strategy for the Trader Portfolio, focusing on volatile stocks with high target.

The situation today still looks a lot like the one in 2003, and the strategy for the Trader Portfolio has given good excess returns. The Trader Portfolio continued performing well throughout 2003, also long after the stock exchange had reached bottom and was rising. We believe the same will happen this time.

Many companies are still way down compared to the top in 2008. Some might have gone up 50 % or 100 % since the bottom, but if they first fell by 90 % this means that they still have a fall of 80-85% since the top. Target is still significant in many companies.

Insiders have been actively buying for some time. Investtech’s insider trade analyses in Norway and Sweden show 80-90% buys among trades in the past quarter, and almost as much over the past year. All the insider buys show that many insiders are positive to their own companies and that the fundamental conditions may not be as bad as many have feared.

We also see that the investors are more optimistic again. After a low of less than 5 % optimists before Christmas last year, the number of optimists as measured by Investtech’s Hausse indices has risen to around 50 % for Norway and 70 % for Sweden as of May 6th. Investors are once again seeing the long-term excess return of the stock markets and not just the short-term risk. This will trigger buy signals at different times in different companies. Using technical analysis in the short term will demonstrate where the news is turning, optimism is increasing the most and the money is coming in, providing the opportunity to get in on this before most other people.

Strategy in today’s market

Based on the successful criteria of 2003, which have given good results so far in 2009, we believe the recipe below will give good results in the stock market in the time ahead, given the opportunity to follow the market fairly closely and the desire to take high risk. Please note that the strategy can lead to big losses if the market should fall. However, statistically the risk/reward ratio, i.e. the gain considering the risk, appears very conductive for this strategy.

• Buy stocks only in companies where the insiders are positive. That the people who know the fundamental side of the companies well are positive and feel that the price should go up, provides a level of security.
• Volume development must be positive. The easiest way to see this is that "VolBal" arrows on the standard chart are green and pointing upwards. Studying the candlestick chart gives an especially good picture of volume development. Here we would like to see that the high volume columns are green (high volume on days with price increases), while the low ones are red (low volume on days with price falls). Some of the best buy opportunities are when the price reacts back on low volume after a period of increases.
• Another leading indicator is a positive divergence pattern between RSI and the stock price, i.e. the RSI curve is rising while the price curve is falling or moving sideways. It is possible to combine these, but it is Investtech's experience that RSI often gives signals too early, resulting in volume development being a more reliable indicator.
• Buy signals from inverse head and shoulders formations, double bottom formations and rectangle formations are considered reliable indicators that a rising trend has begun. These indicate that the pessimists have now sold their stocks and the optimists have taken control. An increase in volume at the same time as the buy signal will strengthen the signal. The very best buys are often available when the price falls back on reduced volume, down towards support from formation, after having been up for a couple of days.
• In general, breaks up through resistance give good signals in a rising market. There were sellers who wished to get out on previous price peaks or on break even levels. The price breaking up indicates that the sellers are not around, but investors are still interested in buying. This sets the scene for further increases. Now there is also support where the resistance used to be, so in many cases the downside is small.
• Good candidates are also stocks that have reversed, perhaps established a rising trend in the short term, but reacted back in the past few days or weeks. In a rising market, support almost always stands. This makes for a good entry price and target.
• Be ready to take losses quickly. In particular high risk stocks can fall a lot if the market continues down. However, beware of using automated stop loss, especially in less liquid stocks. Set stop loss limits, but make sales manually to limits.

Tools

How to find stocks that fit into such a strategy? Investtech provides several tools that can be useful.

The various technical charts show identified trends, volume development, support and resistance, formations, etc. When companies of interest are identified, this is obviously the place to decide on suitable limits and the timing of buying and selling.

The Signals menu gives an overview of stocks that have given buy signals from various indicators, for example double bottom formations. This requires a Professional subscription.

Top50 displays the stocks that are the most positive based on technical criteria, and for Norway and Sweden also based on insider criteria. Stocks that have rising trends, are close to support or have broken through resistance and have positive volume development will be high up on such a list. The short term list is the most relevant, perhaps in addition to the list based on overall analysis where insider trades are included. These require Trader and Professional subscriptions, respectively. Also medium term Top50 (Investor subscription) is considered very useful, but mostly when the turn up has been going on for a while.

Trading opportunities displays stocks that have strong combinations of technical criteria. Suggestions are made for favourable buy prices, stop losses and targets. This service is available for Professional subscribers.

The Trader Portfolios for Sweden and Norway are updated once a week. Check here for ideas on which stocks to buy. However, beware of following the portfolio directly, as some stocks could see a high initial rise. A better strategy then could be to find similar stocks, or set limits and buy in a day or two, rather than being too aggressive to get in.

For Sweden and Norway, the ranking lists of stocks positive on insider trades can provide good ideas for stocks that are fundamentally positive. These stocks can then be bought when they are also technically positive or volume and/or RSI indicate that they will rise. The I icon on the chart site provides details on insider trades for each stock.