Selection of Markets & Issues

1. SELECTION OF MARKETS
AND ISSUES: TRADING AND
INVESTING

2. SELECTION OF
MARKETS AND
ISSUES: TRADING &
INVESTING
Section I – 39%
• Which Issues Should I Select for Trading?
- Choosing Between Futures Markets and Stock
Markets
Which Issues Should I Select for Investing?
• Top-Down Analysis
• Secular Emphasis
• Cyclical Emphasis
• Stock Market Industry Sectors.
• Bottom Up—Specific Stock Selection and
Relative Strength
• Relative Strength
• Academic Studies of Relative Strength .
• Measuring Relative Strength .

3. SELECTION OF
MARKETS AND
ISSUES: TRADING &
INVESTING
Section I – 39%
• Examples of How Selected
Professionals Screen for Favorable
• Stocks
• William O’Neil CANSLIM Method
• James P. O’Shaughnessy Method
• Charles D. Kirkpatrick Method
• Value Line Method
• Richard D. Wyckoff Method

4. Which Issues Should I Select?
• Investment requires a certain aspect of the investor's time and energy, not to
mention knowledge and psychological makeup, to profit.
• Investing, including trading, breaks down into four general categories:
1) buy-and-hold - Buy-and-hold, basically a fundamental exercise in company
and economy analysis, can be done once a year if necessary but more likely once
a month, and drawdowns are of little concern because if the portfolio is properly
diversified, whatever price declines that occur will likely be reversed over time.
2) position trading - Position trading takes more fundamental and technical
research because the positions will turn over more frequently and usually an exit
strategy is necessary, forcing the investor to watch positions more closely, say
once per month or every few weeks.

5. Which Issues Should I Select?
3) Swing Trading - Swing traders hold a position between one day and several
months but mostly for only a few days or weeks. This method requires daily
charts and daily inspection for patterns and leadership. swing trading requires a
daily commitment that can still allow time for a job.
They program their computers to search for new highs and lows, gaps, one- and
two-day reversal patterns, range and volatility changes, volume changes, moving
average crossovers, and any number of other short-term indicators of possible
trend change in individual stocks and contracts.
4) Day Trading - day trading is completely technical and based on technical
criteria such as price, volatility, tendency to trend, liquidity, volume, and a myriad
of other technical evidence. Day trading requires a complete commitment to the
markets

6. Factors consideration
Future V/s
Cash Market
Costs Risk
Suitability Time Horizon Volatility
Liquidity Volume
Trading (Swing
and Day)

7. Which Issues Should I Select for Investing?
Top Down
Secular
Emphasis
Cyclical
Emphasis
Intermarket
Analysis
Bottom Up

8. Top Down Approach
• Top-down analysis begins with a study of the major markets such as
interest rates, currencies, commodities, and stock market to determine
which market has the highest possibility of profit in the future.
• Top-down investing is an investment approach that involves looking at the
overall picture of the economy and then breaking down the various
components into finer details.
• After looking at the big-picture conditions around the world, analysts
examine different industrial sectors to select those that are forecast to
outperform the market

9. Top Down Approach
• By first analyzing the overall picture, such as a macroeconomic trend, an
investor can start narrowing potential companies to analyze. A trader that
uses technical analysis may use top-down analysis as part of their trading
system.
• A day trader may first analyze daily or weekly charts to determine the
asset's longer term trend, and strong support and resistance levels; and
then move to a smaller time frame of charts, to determine a good entry
point.

10. Bottom Up Approach
• Bottom-up investing is an investment approach that focuses on the
analysis of individual stocks and deemphasizes the significance of
economic cycles and market cycles.
• The investor focuses his attention on a specific company, rather than on
the industry in which that company operates or on the economy as a
whole.
• This approach assumes individual companies can do well even in an
industry that is not performing.

11. Bottom Up Approach
• This approach assumes individual companies can do well even in an
industry that is not performing.
• Bottom-up investing forces investors to first consider microeconomic
factors.
• These factors include a company's overall financial health, financial
statements, products and services, supply and demand, and other
individual indicators of performance over time.
• For example, a company's unique marketing strategy or
organizational structure may be a leading indicator that causes a
bottom-up investor to invest.

12. Secular Emphasis
• the concept of alternating emphasis in the markets on hard assets
and soft assets over long secular periods.
• Secular is a term used for any period longer than the business cycle.
• Hard assets are solid commodities such as gold and silver; these
assets traditionally are considered an inflation hedge.
• Soft assets are financial assets, called paper assets, which primarily
include stocks and bonds.
•

13. Secular Emphasis
• The reason for the inverse relationship between the value of hard
assets and of soft assets is that a close correlation exists between
material prices and interest rates.
• Inflation, or higher material prices, is generally associated with higher
interest rates.
• When inflation becomes a threat, paper assets, which decrease in
value as interest rates rise, are undesirable as investments.
• when hard asset prices decline, interest rates usually decline, and soft
assets increase in value.
• The theory that one or the other of these kinds of assets becomes
popular for substantial periods is not a new one.

14. Secular Emphasis

15. Cyclical Emphasis
• The longer secular economic trend are a number of business cycles.
• These business cycles are of varying length but usually average around
four to five years.
• These business cycles are the normal horizon for most economists,
business managers, and investors.
• It is well recognized that leadership in the trading markets often switches
within the business cycle.
• Investment markets into three categories: commodities, bonds, and
stocks. The business cycle affects each of these markets but in different
ways.

16. Cyclical Emphasis (U.S. Dollar and Gold )
• Murphy maintains that currency rates
influence industrial prices but
sometimes with a considerable lead.
• The dollar is important in that it is the
pricing currency for many of the world's
raw materials such as oil, gold, and
other precious metals.
• When the dollar declines, it makes these
commodities cheap in foreign currencies
but expensive in dollar terms.
• Thus, there is a leading inverse
relationship between the U.S. dollar and
raw materials prices in the United States

17. Cyclical Emphasis (Gold and Bonds (Long-Term Interest Rates))
• By taking a ratio of the gold price to the U.S.
Treasury bond futures, we see that at certain
times, a signal is given by the ratio as to when
to enter or exit the long-term bond market.
• The reason is that the upward crossover in the
ratio is not confirmed yet by an upward
crossover in the favored gold price.
• On the other hand, the bond market is edging
slightly below its upward trend line and is in a
position to be sold.
• The bottom line is that the gold futures need
to progress higher to confirm their relative
strength, but bond futures can likely be sold
right now.

18. Cyclical Emphasis (Bond Market and Stock Market )
• Normal business cycle sequence, the next
switch in markets is from the bond market to
the stock market.
• Actual deflation has become a threat and has
upset the previous balance between interest
rates and the stock market.
• Nevertheless, a plot of the ratio of bonds to
stocks, as shown in Figure 16.6, shows definite
times when one or the other has the
advantage.

19. Cyclical Emphasis (U. S. Dollar and the Stock Market )
• The final analysis is to return to the
beginning and see how the dollar and
the stock market have interacted.
• The dollar usually leads the industrial
raw material market, which in turn
generally leads the bond market, which
in turn leads the stock market.
• Dollar now has an excellent timing
relationship with the stock market.
• The dollar to stocks ratio gave a buy
signal for the dollar and a sell signal for
the stock market in December 2007,
right at the peak in the stock market.

20. Relative Strength
• https://www.investopedia.com/articles/trading/08/relative-strength.asp

21. Measuring Relative Strength
• Relative strength is a momentum investing technique that compares the
performance of a stock, exchange-traded fund (ETF) or mutual fund to that of the
overall market.
• By using specific calculations, investors can identify the strongest performers
compared to the overall market, creating recommendations for investments.
• When used as part of the aforementioned investment strategy, relative strength
assumes a stock whose price has been rising will continue its upward trajectory.
• Relative strength creates a point of comparison regarding the performance of a
particular security against the performance of a selected benchmark, such as a
market index, as well as to other similar securities.
• Relative strength investing has both an entry and exit strategy; investors using this
technique aim to buy securities exhibiting signs of strength while selling their
holdings as soon as the associated securities begin to appear weak.
• An investing technique in its own right, relative strength can also be applied to more
complex strategies, such as pairs trading.

22. Measuring Relative Strength
• Relative strength is a measure of the price trend of a stock or other financial
instrument compared to another stock, instrument or industry. It is calculated
by taking the price of one asset and dividing it by another.
• For example, if the price of Ford shares is $7 and the price of GM shares is $25,
the relative strength of Ford to GM is 0.28 ($7/25).
• This number is given context when it is compared to the previous levels of
relative strength.
• If, for example, the relative strength of Ford to GM ranges between 0.5 and 1
historically, the current level of 0.28 suggests that Ford is undervalued or GM is
overvalued, or a mix of both.
• It should also be noted that the ratio can also increase by combining an
upward price move of Ford with a downward price move of GM. For example,
if Ford shares rose to $14 and GM shares fell to $20, the relative strength
would be 0.7, which is near the middle of the historic trading range.

23. Measuring Relative Strength
Percentage
Change
Method
Alpha Method
Trend Slope
Method
Levy Method
William O'Neil
CANSLIM
Method
James P.
O'Shaughnessy
Method
Charles D.
Kirkpatrick
Method
Value Line
Method
Richard D.
Wyckoff
Method

24. Percentage Change Method
• Jegadeesh and Titman used a six-month price change as their basic lookback
calculation.
• Lookbackis the period over which relative price strength is calculated.
• The stocks then were sorted based on these rates of change.
• They found that the higher decile stocks continued to be strong for the next
three to ten months.
• Their sample included both large capitalized and thinly capitalized and both
high-priced and low-priced stocks.
• All performed similarly both in the original experiment and in the subsequent
out-of-sample tests.

25. Alpha Method
• Modern Portfolio Theory (MPT), stock prices are compared with an average,
usually the S&P 500, weekly, over a year (and sometimes with different time
intervals and period).
• The weekly percentage change in the stock price is plotted versus the weekly
percentage change in S&P 500, and a linear regression line is drawn through
these plots on a best-fit basis.
• The line so defined is expressed using the slope of the line, called the beta, and
the intercept with the vertical axis, called the alpha.
• Each stock over a specified period has an alpha and a beta. Traditionally, beta
has been used as a measure of volatility relative to the S&P 500 and considered
a definition of market risk.
• Stocks that have a steep slope in their regression line and have a high beta
demonstrate a proclivity to have higher gains than the S&P 500 when the
market is higher but, also, larger losses than the S&P 500 when the market is

26. Alpha Method
• Alpha describes the value when the regression line crosses the 0% change in
the S&P and is, thus, a measure of the trend relative to the S&P 500.
• MPT suggested that high beta stocks would be more profitable but would also
be more risky.
• What they missed is that high beta stocks could also have negative alphas,
suggesting that, although more volatile, their trends relative to the S&P could
be downward.
• When alpha is compared among stocks, it provides a relative strength measure,
and stock lists can be ranked by alpha to show which issues are the strongest.
• Alpha will change more frequently and more widely than beta, but beta is
somewhat irrelevant to the relative price strength and has been largely
discarded, even as a measure of volatility.

27. Alpha Method
• AAPL's beta of 1.6 implies that AAPL stock will,
on average, move 60% more than the S&P 500 on
a weekly basis.
• The alpha of 1.55 indicates that AAPL has been
outperforming the S&P by 1.55% on average over
the 52 weeks in the plot.
• It thus has a positive alpha and is a strong stock.
Comparing AAPL's alpha to that of other stocks is
a way to determine the strongest and best
candidates for investment.
• Graph shows alpha and beta of AAPL versus
Standard and Poor’s 500, on SPX from minus 20 to
30 versus AAPL from minus 60 to 80 with plots for
alpha equals 1.55 and beta equals 1.60.

28. Trend Slope Method
• The screening for relative price strength is to calculate the slope of the
price curve in percentage terms over a specified period through a linear
regression formula for each stock.
• The stocks can then be ranked by the slopes of their price curves.
• This method is similar to the alpha method and to the Jegadeesh and
Titman method.
• It is easier to calculate than the alpha method and does not suffer from
the drop-off effect of a rate-of-change calculation beginning at an arbitrary
price.

29. Levy Method
• Levy first calculated the ratio of the stock's current price to its 131 trading-
day moving average.
• He then ranked this ratio against the same ratio for all other stocks.
• Levy also found that when the overall stock market headed downward
into a lengthy bear market, relative strength continued to be reliable but
gradually lost its ability to pick winning stocks,
• When the final decline, the washout, occurred, those stocks having been
relatively the strongest usually declined the most.
• In his estimation, relative strength was, thus, a bull market selection
process and should not be used when the stock market declines.

30. William O'Neil CANSLIM Method
• CANSLIM is an acronym for a method of picking stocks to buy, devised by
William O'Neil (2002), publisher of Investor's Business Daily.
• The breakdown of CANSLIM is as follows:
C—Current quarterly earnings per share versus a year earlier
A—Annual earnings increases
N—New products, management, and stock price highs
S—Supply and demand of stock
L—Leader or laggard
I—Institutional sponsorship
M—Market direction

31. William O'Neil CANSLIM Method
• Technical analysts, are only concerned with L and M.
• To determine L, leader or laggard, O'Neil calculates the 12-month
percentage price change of every stock, weighted more heavily over the
most recent 3 months, and ranks each stock in percentiles from 99 to 0,
with 99 being the strongest.
• The weighting over the past 3 months reduces the overall time for
comparison and, therefore, improves the prospects of price strength
continuing.
• O'Neil found that the average relative strength percentile, by his
calculation, was 87 before large upward moves.

32. William O'Neil CANSLIM Method
• For M, market direction, O'Neil refuses to listen to newsletters and “gurus”
and refuses to use economic data because it lags behind the market.
• He has a number of specific indicators and patterns he watches for signs
that a market is bottoming.
• He believes that the buy-and-hold method is faulty because the widely
held belief that all stocks will recover after a bear market is a myth.

33. James P. O'Shaughnessy Method
• He studied market capitalization, price-to-earnings ratios, price-to-book ratios, price-
to-cash flow ratios, price-to-sales ratios, dividend yields, earnings changes, profit
margins, and return on equity.
• He found that relative price strength, out of all the possible variables, fundamental
and technical, was the only “growth variable that consistently beats the market”
• It takes a ratio of the yearend price to the price one year prior. It is, thus, a 12-month
relative price strength measure, a slightly longer-term calculation considering the
history of relatively strong stocks remaining strong.
• A multifactor investment strategy model called the Cornerstone Growth Strategy. It
includes a primary screen for stocks with a price-to-sales ratio below 1.5, earnings
greater than the previous year, and of those selected so far, the top 50 stocks in
relative price strength.

34. Charles D. Kirkpatrick Method
• in using the stock price, he calculates the ratio of the
closing price to the stock's moving average and then
ranks all stocks by their ratio.
• Second, Kirkpatrick uses the Levy calculation of relative
price strength over six months in line with Levy's original
work and that of later studies showing the importance of
that period for post calculation continuation of price
strength
• Current relative price strength percentile from 2 to 97
versus relative price strength percentile three months
ahead with plots for best fit percentiles, actual
percentiles, and market average performance (50
percent).
• It is positive, which suggests the higher the current
relative price strength percentile, the higher will be the
relative price strength percentile three months later. The
best three-month performance comes from the highest
level of current relative price strength percentile.

35. Value Line Method
• The Value Line Ranking System (www.valueline.com) has an extraordinary
history of outperforming the stock market.
• Value Line claims that its Timeliness Ranking system has outperformed
the Standard & Poor's 500 by 16 to 1 since 1965.
•
• the company will not divulge its method of calculation, it does admit that
a significant portion of it includes a calculation of relative price strength.
• Factors include earnings trends, recent earnings, and earnings surprises.
Value Line charges a fee for its stock services.

36. Richard D. Wyckoff Method
• A method of profiting from the stock market using technical analysis and
relative price strength that has stood the test of more than 80 years is the
method that has been taught by Richard DeMille Wyckoff
• Wyckoff believed most strongly that stock prices were determined solely
by “supply and demand.” He had little use for “tips, rumors, news items,
earnings analyses, financial reports, dividend rates, and the myriad of
other sources of information” or the “half-baked trading theories
expounded in boardrooms and popular books on the stock market

37. Richard D. Wyckoff Method
• 1. To determine the direction of the entire market, Wyckoff devised an index called
the Wyckoff Wave that was a composite of the most widely held and active stocks.
• Preferably, the stocks in the index were the ones that the investor or trader was
interested in trading.
• His concept of trend was to watch trend lines drawn on the Wave chart and on charts
of the composite market.
• 2.To select the stocks in harmony with the market, Wyckoff selected stocks that were
strong in upward trends and weak in downward trends. He believed it was futile to
act against the trend.
• His calculation of relative price strength used the percentage changes from wave
highs to lows and lows to highs of each stock versus those of the Wyckoff Waves.
• Those stocks that consistently outperformed in each wave in the direction of the
longer wave trend were the ones to analyze further.

38. Richard D. Wyckoff Method
• 3.To determine the potential of those selected so far, Wyckoff used the point and
figure horizontal count.
• At the same time, a stop level was established, and for the stock to be considered
further, a three-to-one ratio of potential gain to potential stop loss was necessary.
• 4.To determine if the stock is ready to move, shorter-term considerations were
needed to analyze the nature of its price action.
• To do this, Wyckoff relied on volume, range, and to some extent, short-term
momentum. This portion of his method relied heavily on experience and judgment.
• 5.To time the entry, Wyckoff based his decision on the turning in the overall market.
• His basis for this principle was that most stocks move with the market direction, and
timing with the market change reduces the risk of error.