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What Goes Up, Sometimes Stays Up

18 November 2013 in Trading Ideas

We’ve all the heard the stories – the investor who bought Netflix at $11, Apple at under $10 and Netflix for $15. These are once-in-a-lifetime investments (if they’re even true), but they do showcase that ultimate prize for investors: finding that next breakout stock.

For many of us, though, breaking out doesn’t have to mean choosing a $10 stock that will be at $1,000 in two years, it’s about following the short-term messages of stock-price movements to determine when a rising stock is one to potentially believe in.

That was the thinking behind our new Higher Highs motif, a portfolio of stocks that have recently broken above their 120-day trading range, regardless of whether it’s happened because of company news, investor risk momentum or predicted technical measures. By attempting to minimize the risk of retracement, the motif tries to single out stocks that look bound for equilibrium at a higher price point.

Here’s how we do it: We start with a focus on the top three-quarters of stocks in terms of market cap and trading volume in an attempt to avoid liquidity and volatility issues. Next, we single out stocks that have climbed to a price within the past 30 days that exceeds any highs of the previous 120 days.

Then we kick out stocks with either unusual overnight price moves, or recent large volatility increases (when compared to five-, 30-, and 120-day trading ranges). After that, we eliminate stocks that suggest they’re in the middle of a larger negative price momentum over the past year.

Finally, we exclude any stocks that would have qualified given the above parameters within the previous two months.

Once the motif stocks are in place, the portfolio is rebalanced every week – any stocks that begin showing negative price action are exited at that time.

As one more measure of quality control, no stock can have more than a 20% weighting in the motif. If conditions are such that fewer than five stocks are eligible for the motif, that portion of the weighting will be held in a short-term Treasury bill exchange-traded fund.

Investors interested in technical stock analysis and/or in finding stocks that break above previous ranges may like this motif as an alternative or complementary strategy.