Unless you can develop a considerable trading edge over other traders, you are likely to lose money—even if you’re disciplined and organized. In this article, I discuss some elements I use to create my trading edge.
Fundamental Analysis
Fundamental analysis involves evaluating the financial condition of a company by analyzing financial reports, price/earnings ratios, revenue, sales, growth, etc. This can be time-consuming, so instead, I rely on Investor’s Business Daily (IBD) for a quick overview.
IBD ratings include:
- Earnings Per Share (EPS) Rating: Measures short-term and long-term earnings growth, ranging from 1 to 99, with 99 being the best.
- Relative Price Strength (RS) Rating: Measures price changes over the last 12 months compared to other stocks, ranging from 1 to 99.
- Industry Relative Price Rating: Compares a stock’s industry price action to other industries, rated from A to E, with A being the best.
- Sales, Profit Margins, ROE Rating: Combines sales growth, profit margins, and return on equity, rated from A to E.
- Accumulation/Distribution Rating: Analyzes price and volume changes over 13 weeks to determine buying or selling pressure, rated A to E.
I use fundamental ratings for longer-term trades. It’s not particularly useful for intraday trades.
Technical Analysis
Fundamental analysis helps build a list of strong stocks, but it doesn’t provide specific entry and exit points. For that, I rely on technical analysis—studying price actions that form patterns on charts, which often repeat due to predictable human behavior.
- Support and Resistance: The foundation of every trading decision.
- Support: A price level that a declining stock cannot break through.
- Resistance: A price level that a rising stock cannot break above.
- Oscillators: Indicators like RSI, Stochastic Oscillator, and MACD that determine if a stock is overbought or oversold. I use them to filter stocks but never as direct trade signals.
- Public Sentiment:
- VIX: I look at support and resistance on the VIX (Volatility Index) to anticipate reversals.
- Put/Call Ratio: Helps gauge market sentiment—whether traders are too bearish or too bullish.
- Market Internals:
- TRIN: Measures overbought or oversold conditions using moving averages (MA).
- McClellan Oscillator: Indicates whether the market is overbought or oversold and provides buy/sell signals based on these levels.
- Market and Industries: I prefer to buy stocks from industries in an uptrend and short stocks from industries in a downtrend.
Putting It All Together
Developing a trading edge requires experimenting with various tools and finding the combination that best suits your personality. Take time to find what works for you.
