Developing My Stock Market Investing System Part Two

OK. So, I've taken a little time off from developing my stock market investing system and thought that I would get back to that now. In a previous post called Developing My Stock Market Investing System Part One, I talked a little about market direction and here I thought that I would expand on that. In the meantime, I've given a great deal of thought I what the next steps should be after that and also thought I would go through those decisions as well.

When it comes to investing in the stock market, I see it as breaking down into the following steps. They are:

• Determining market direction
• Screening the stock market today for potential investment opportunities
• Analyzing charts of the stocks that appear on those screens for certain chart patterns like cup with handle, double bottom, saucer, flat base and the like.
• Determining proper buy points
• When to sell your positions

What I want to do is break down each stage of the process in detail here to create a roadmap of where we are going to go with my investment strategy. Keep in mind that as I refine it, I'll tweak it here and there. Also, with any trading strategy, you have to make it your own. You've got to identify an investing philosophy you like and can enjoy. Then you got to set out to become an expert at it. Don't flip flop between strategies. Choose one and go with it. Break down each and every step into a finely tuned investment action plan that you execute daily. Don't leave anything to change.

In choosing an investment style, you have two basic optons. They are:

• Value investing
• Growth investing

If you have been reading my site, then you'll know that I will be focusing on growth investing and particularly the CANSLIM investing approach put forth by William O'Neil in his book How To Make Money In Stocks. To implement his strategy, you will almost certainly need a subscription to the Investor's Business Daily. (You can get a free trial to the IBD by clicking the ad down underneath this post.)

Let's get on with it.

Determining The Stock Market's Direction

As I write this, the market is in a correction according to the IBD Big Picture Column which analyzes the overall trend of the market. Each and everyday, you must review the market's direction. It's been documented by O'Neil that 3 out of 4 stocks follow the trend of the market. Rule number one is to never invest in the market when the market is in a downtrend. Only invest when the market is in a confirmed uptrend.

Each day what I do is analyze the four major indexes for price and volume action to get a feel for what happened in the market today and you should too. This information is free at investors.com and you should utilize it daily even if you don't have a subscription.

Once you start to look at this data every day, you'll start to notice that you do the same thing every day. That's why you should take this a step further and break what you are doing down to a specific set of steps, or investing checklists, that you follow day in day out. Start by putting these steps down on paper and then refine them as you use your checklist to put into place a quick action plan you can follow after the market closes each day.

Here is what I've done so far as far as market direction goes in my investing checklist:

-- Determine The Stock Market Direction Today --

• Review the indexes for price and volume action
• Review the S&P 500 Composite Index
• Review the Dow Jones Industrial Average Index
• Review the New York Stock Exchange Composite Index
• Review the NASDAQ Index
• Watch the IBD TV Market Wrap
• Read the Big Picture to determine the stock market's direction.

When you are reviewing the indexes, take the time to decide for yourself what the market did today. Was the particular index under accumulation or was it under selling pressure. You can do that by following three basic principles at first.

They are:

• If an index closes higher on higher volume, it's being accumulated
• If an index closes lower on higher volume, it's being sold off - or distribution days
• If an index closes higher or lower in lower volume, ignore it for now

In addition to the price and volume action on the major indexes, you might decide to add some additional secondary indexes. One additional one that I've decided to adopt is from ChrisPerruna.com and relates to the number of stocks making new highs versus stocks making new lows. He talks about it in a post he wrote called New Highs - New Lows Ratio (NH-NL). For now, I've decided to add the following steps to my daily action plan as I get more accustomed to seeing the data I'll incorporate it in my strategy.

Here are the additional steps:

• Record the new highs and new lows from the NYSE
• Record the new highs and new lows from the NASDAQ

He doesn't use the American Stock Exchange.

I've stared putting this data in a spreadsheet. Here's a snapshot of it.

I've got a second sheet that includes the NASDAQ data. For now, I'm just recording that data and as I build it up a history of stats, I'll get back to it. For now, let's move on to the main thing I wanted to talk about today and that was the second step.
Screening The Stock Market Today For Potential Investment Opportunities

Once you've determined the stock market's trend, it's time to start finding potential stocks to invest in. The first step is narrowing down the field of stocks to a few you can concentrate on. This is called stock screening. Stocks are typically screened for certain fundamentals or actions like price and volume.

One of the things that I found tough to do is find information on how to screen stocks. In reviewing, Chris's blog, he made a post called Fundamental Screens and Scans that I found very helpful.

I want to take step back here before I start getting into how I am going to develop my screens and talk a little bit about the ones he has developed. Personally, I like his very much but there's one drawback to using his approach and that is that he uses a tool called the Custom Screen Wizard at DailyGraphs.com. He even gives you the criteria to use. In the article he says that he pays $45 a month for it, but for us to get that screener now, we have to buy it as a total equity package that costs $999 per year or $112 per month. If you are just starting out with limited investment capital, I suggest that you refrain from spending your money on tools outside of the subscription to the IBD. It eats away at your return. What I am going to try and do instead is focus on building my screens from the data I get in the paper each day and from the website. Later, once I feel I can justify it, I will probably spring for the equity package. For now, though let's review the stocks screens he suggests and I will list the alternative to his screens that I will use for now.

1. Quality Stocks within 10% of the 200-day Moving Average

I got the feeling that this is an important scan he runs but I couldn't quite replicate it with the IBD. In it's place, I am going to put the Stocks In The News columns. I felt this would put the leaders on my radar. My choice doesn't match but it was a good replacement.

2. Quality Stocks that are trading within 15% of 52-week Highs

Here, I felt that the Weekly Review column best fits the bill here.

3. Institutional Sponsorship Increasing

In this case, I decided that I would use a combination of screens from the paper. The first one is the Stocks On The Move and the second is a screen of the day called Acclerating Mutual Fund Ownership.

4. Quality Stocks making New 52-week Highs:

I will build this list from the New Highs and New lows. This is actually the easiest screen to replicate. I went through and created the same list the custom screen wizard generated. It just took a little longer.

5. Quality Stocks with a new IPO within the past two Years

In this case, I decided to opt for one of the screens of the day called Young Guns.

6. My official CANSLIM Screen

Here I decided to use the IBD 100.

7. Strong Earnings Increase 40%+

I am going to develop this list from the earnings reports and a screen of the day called Estimate Beaters.

8. Potential Shorting Opportunities

In this case, I don't have the experience to short stocks and will be focusing on stocks to buy long. So in it's place, I'm going to put the IBD Top Composite 200 stocks that is published each week on Thursday.

So there you have it. These are the starting screens that I am going to use to narrow the universe of stocks to a more manageable list to review. That being said, I'm expecting that in bull markets, this will produce a number of stocks to review each day. For now though, what I am going to do is fine tune how I am going to use these screens and the steps I take to put them together.

It will definitely take longer than using the custom screen wizard, but we will see exactly how long it takes here pretty soon.

This will then get me a number of stocks to watch each day. This will be the list of stocks I will use to review charts of and help to build my watch lists for actual purchases of stocks. Check in later as I talk more about that.

Here's a video where I walk you through the same thing.