Picking the Right Stocks Using Charts
by Michael Kahn
Investors are always searching for ways to “beat the market,” and while naysayers abound, studies have shown that individuals can indeed produce superior returns in their portfolios. The best part is that it does not take advanced degrees and high-powered computers to do it.
If half the battle in the stock market is recognizing whether a bull or bear market is in place, then the other half is choosing the right sectors and the right stocks. This is the basis for relative strength or relative performance investing. Find the sectors and stocks that are outperforming the market, ride them until they stop outperforming and then find the next leading area. Indeed, relative performance is represented by not one but two letters in William O’Neil’s CAN SLIM stock selection methodology. “L” stands for leader or laggard versus other stocks, and “M” stands for leader or laggard versus the market.
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They Keep Going and Going…
It is not difficult to uncover the leaders in the market, but that tells us what has already happened. Fortunately, the stock market has inertia, a term borrowed from physics stating that bodies in motion tend to stay in motion. Leaders tend to keep leading and laggards tend to keep lagging. Charles Kirkpatrick, a certified market technician, has shown that this simple concept, combined with relative earnings growth, beat the market for a period of over 17 years. His research served as the basis for a stock screen highlighted in the November 2009 AAII Journal (“Building Stock Screens Using the Kirkpatrick ‘Relative’ Approach,” by Wayne A. Thorp, CFA).
There are two basic methods of finding the current leaders. The first is to rank the individual performances of all stocks over a specified period of time. Of course, we can weed out undesirable stocks using such criteria as earnings growth, trading volume, market capitalization and price, but the goal is to produce a manageable list of strong candidates for further analysis. The second method, which I will discuss momentarily, is to look for good sectors first.
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