TERN - My Methods For Finding The Best Stock Portfolio - Part 2

2023-05-09 08:19:46 ET

Summary

• I present additional information about my methodology for finding the best stocks.
• Some of the technical tools I use to make final decisions to buy or sell.
• The leadership of certain stocks and sectors changes occasionally, and we can take this into account by varying the lookback timeframes.

I would like to thank all those who commented on the first part of this article as it gave me many ideas and alerted me to some incomplete ideas which I must explain further. I certainly appreciate the input.

The primary complaint was about how I think one should rotate stocks in and out of the portfolio. I thought that I had explained this but apparently, I did not to the satisfaction of many readers so I will attempt to do so here. Possibly I thought that it was an easier idea than it is so here goes.

With my list of 72 stocks, each time I update the data in my spreadsheet, I sort by the annual rate of interest. In this column, I use the "RRI" formula which determines the rate of interest on an annual basis for the data I start with the approximate date of the lowest low of the current trend. This gives me a ranking that normalizes the return for the entire list. I could easily do this with ROC, but I just chose RRI. My reasoning for using the most recent low in this case will be explained below. Currently, I reconfigure the entire list once a month. That is, I review each system list to find if there are any new top stocks and recreate my overall list of 72 top potential investments. It is always possible that the overall list would grow or shrink depending on the results of this research. Quite frankly, completely revising each week is a bit too much work for what I consider too little reward. I don't think that the models will change very often, except for the Top Weighted Alpha group which changes quite often. This is due to its methodology (totally technical).

With the list completed, I look at the charts of each of the stocks at the top. As I stated earlier, I do not like 'shooting stars' on the list. I look to see if the stock in question is just such a stock, and if it seems to make large troughs during the time in question, I reject it. This is a judgment call. What I'm looking for is consistency in the trend, which shows me, generally, what investors think of this particular stock. I also look at the indicators. The indicators of the stocks I pay the closest attention to are:

• On Balance Volume
• Advance Decline Line
• Volume

These tell me what investors think about the stock. If the OBV and A/D lines are high and/or moving up, and volume increases during advances of the price, I know investors are interested in this stock. Ideally , t he volume should be trending up as the price does so. I always look at these indicators before buying any stock. These sentiment indicators are very important and date back to Edwards & Magee (Charles Dow).

The fundamentals are taken care of by how I derive the stocks in the first place. I am relying on the best professional minds to tell me what the best stocks should be based on fundamental criteria, and I use technical analysis to make my final choice. The technical indicators I use most, besides the ones listed above, are trend lines. It would be nice if the MACD and Stochastics would be favorable (and I do look at them), but the main trend indicators I use are trend lines (support and resistance). Over the last 45 or so years that I have been drawing them, I've learned that these tools are probably the most important in the toolbox. Charles Dow first developed the rules for drawing and interpreting them and I've learned over the years that they are probably the most reliable tools we can use to trade the markets. The rules I use to draw them are that the line must hit at least 3 points on the price trend. The more the merrier. I will sometimes draw 2 lines if there seems to be more than one that the prices develop. Try different support lines and see if they work out to be better. It's free to try anything on the chart so go at it. The trend lines tell us when a possible change in the direction of the trend is near. Trend lines organize the chart in a way that one can see the patterns on them.

On my list of potential investments, stocks move up and down the list constantly. When a stock enters the top 9, I look at the chart of that stock to determine if it will become part of my top selections. The chart will tell me all I need to know. If a stock moves down, it gets removed but since it was important before, I would keep my eye on it. It may have fallen out of favor with investors and should be removed or it may just be in a retracement. If it falls out of the top 20, for sure It would be out. This usually happens with stocks in the "Top Weighted Alpha" group mostly, but it doesn't matter where I got them. That is why I review it so often. Very good stocks that remain on the list for a long time would tend to remain top picks so long as they remain profitable. My goal is to find the best stocks right now. It is very unwise to fall in love with any stock regardless of what it does. I held AMD for years but it has fallen out of favor, so it is out. It's still a good stock and would be a good investment, but it is no longer one of the "Top" stocks. On the other hand, NVDA has been on the list for years and will remain there until it goes bad. The stock list is self-regulating in this respect.

Another self-regulating characteristic of my method are the sources of my stock list. I am not in love with any of the models used to determine the fundamental criteria for selecting the best stocks. As I said in my first article, I reviewed over 20 different models (more like 30) and I chose the ones I did because they seem to outshine the others. However, I can just as easily add or remove models as I can determine their worth. I didn't include "CAN-SLIM" and Warren Buffett's criteria, not because they were not good systems, but because they seemed redundant. They are both good systems, but I think they were too much like those I had already chosen. If some system sounds good in the future, chances are that I will add it to the list. Who am I to reject some good system just because I hadn't used it before? I always keep my eyes open to new advances in understanding ( Verstehen ).

Look-Back Distance

Some commentators mentioned that my look-back distance may not be appropriate for making the decisions that I do. I started with the approximate date of the lowest point of the market back in October of 2022 (actually, the bottom was on the 13th rather than the 3rd where I started). The reason for this is that I discovered that stocks and sectors change leadership at these times. For instance, from January 2,2022, through the present, the Energy sector dominated the market as can be seen by the chart below:

The Healthcare sector was above the S&P, and Utilities was otherwise the top-performing sector. This chart is showing the ETFs of the major sectors in the market. One can see all of them on Seeking Alpha. If one were to invest using this chart, he would be misled into thinking that the energy sector would dominate all others and that is where investment funds should go. However, look at the chart below showing the sectors from October 12th:

The chart shows that the energy sector did well until early December, but later became the worst sector rather than the best. Number one has been the Industrial sector , and Healthcare dropped well below the S&P. This chart does not show all 11 sectors, obviously, but it is easy enough to download the data into a spreadsheet or to compare the data in graphical charts online. The Consumer Discretionary sector remained a poor one in both timeframes.

Currently, I do not know what the ideal look-back timeframe is, but I am studying the question to determine if there is one. Is it the same with a Bear Market? I don't know that yet either, but I will write about it when and if I figure it out. The best I can do now is to say that I like the major turning points, between 3 months and a year in the past. Why does the market turn in the first place? Something changed. Possibly it changed just because it got too far in one direction or the other and is trying to revert to the mean. Or possibly something fundamentally changed in the economy that indicated a major event. Some investors may know what that might be, but I don't. I can only try to observe the result of the event and react. During a trending market, it might be wise to choose varying timeframes and decide at the time. I must conclude that look-back times should vary and one cannot rely on standard 1-, 3-, or 5-year lookback periods to make investment decisions. A stock issue can remain in the portfolio for 20 or 30 years but should be reviewed periodically to determine its value in one's overall strategy. If a stock is held regardless of its potential profitability, then you are holding it for other reasons, probably grounded in emotional motives. This isn't necessarily wrong, but one should be aware of why one holds a position.

These are my latest 15 top stock selections as of May 5, 2023:

VKTX , ARDX , MLTX, CBAY , ETNB , JBL , ASRT , SMCI , NVDA , ELF , SHOP , TERN , ACLS , TDW , & BLDR .

This week EDU dropped out of the top 15, though it still is a great stock and returned at a rate of 135.1% annual profit rate since October 3rd. BLDR took its place on the list. Since it did not drop below the 20th level, I would still hold it if I had it.

Conclusions

There is still a lot of work to do to determine the best lookback distance for finding the greatest probability stocks. However, this is still my most important area of study and I expect to find better and better methods to determine what are the best stocks to buy. I recommend looking into the above stock selections for good investment ideas. My previous article shows my general philosophy and methods for finding what I believe are the best stocks in which to invest.

Is my methodology the only one to rely on? Obviously not. I rely on other models myself to find candidates so why shouldn't you? My criteria are shorter term than many other systems as I want to find maximum profitability, but for finding "buy and hold forever" type stocks, there are several other systems that seek to find such investments. My original portfolio was of this type and I am happy with the selections I made for a long-term portfolio. The reader should review Part 1 for a list of these and the methodology I used to create the list.

For further details see: