A chart-based stock picking framework for passive investors

This chart-based framework for picking bullish turnaround stocks is meant for passive investors. It is targeted at individuals who fit the descriptions below.

  1. Not acquainted with technical analysis.
  2. Not acquainted with fundamental analysis.
  3. Take little effort to inform oneself through reliable sources such as company releases, financial statements, charts etc.
  4. Relies on broker recommendations, headlines, word of mouth from fellow investors (who tend to fit the same mould).

Over long I noticed that this class of individuals make up the majority of retail investors. Additionally I feel that most literature on technical analysis cover short term trading while fundamental analysis deal with longer time frames. There appears to be a knowledge gap for investors who are willing to look at charting techniques applied to horizons longer than 3 months.

I asked some why they would not inform themselves, these are the typical feedback:

  1. Fundamental analysis – don’t know where to look, job busy don’t have time.
  2. Technical analysis – very difficult, cannot understand concepts involved.

 

Picking bullish turnarounds

I gave this many thoughts and over time I believe that this framework below might be simple to adopt for passive investing (not for trading).

Starting points are:

  • Technical analysis is impenetrable to most individuals so the most effective way to introduce charts must be based on elements that individuals already recognise with. My framework requires passive investors to look at quarterly price performance of listed companies. To do this, take any daily or weekly chart and segment the time axis into quarterly segments – there should 4 quarters of 3-months each in a year. This is easy to understand – I take for granted everyone should have the concept of time and most working adults are also familiar with the concept of a financial year for enterprises and 4 financial quarters in a year. So nothing new here.Colour each quarter from high to low into boxes.

 

  • Investors to look at companies with quarterly financial reporting; ignore all other sources of information. There is only one reason – most passive investors will not spend time to handle, might not have access to credible timely sources, or might not have the sophistication to understand the impact of day to day information. These become noise. The idea is then to abandon the whole lot and to focus on one thing only – the quarterly performance inside an official financial statement.

 

  • Quarterly price action of stocks should trend more or less in line with quarterly financial performance. Because stock markets tend to be forward looking, stock prices could lead actual financial performance by a quarter but mostly they should be in line. A company’s quarter performance beats the previous quarter -> stock prices should beat the previous quarter’s performance.A company’s quarter performance falls below the previous quarter -> stock prices should fall below the previous quarter’s performance.

 

Visually, a company that beats every quarter should print rising quarterly price action in a series of higher highs and higher lows. After talking to many new investors, this is a concept that they can accept. Note that exceptions are possible.

 

How to apply such a framework

Application should go like this:

  1. If you expect a company to do well, the quarterly stock price should be trending up. This should be confirmed by financial reporting that should deliver a performance in line with this expectation
  2. If they diverge, investigate further or pass.
  3. If you expect a company that has been performing badly to bottom/pickup, then quarterly price action should do a bullish expansion; concurrently expect a financial reporting that should surprise on the upside.
  4. Without a directional change in price or company performance, expect trend to continue i.e. ‘business as usual’.
  5. Interpretation of the chart would be identical to this ‘Price action trading can be easy with Tflow®‘.
  6. Theoretically a genuine turnaround in stock price should look like the illustration below. Once price makes a new high compared to the last quarter, investors could then wait for retracement to pick up a discount. Without a new high (first blue box), price could continue to move lower.
Theoretically this is what a genuine turnaround in stock price should look like on a quarterly performance

Theoretically this is what a genuine turnaround in stock price should look like on a quarterly performance

 

My question to readers:

  • If you are an investor looking at buying stocks and holding for 3 months or more, is this idea of looking for turnaround logical?

 

It looks perfectly fine to me. In fact quite a number of good ideas we spotted this year fit this framework. The 4 charts of Soybean, Coffee, Palladium and Natural Gas were captured on 21 November. Earlier discussions were posted on Soybean, Coffee and Natural Gas.

Soybean quarterly price performance

Soybean quarterly price performance

Coffee quarterly price performance

Coffee quarterly price performance

Palladium quarterly price performance

Palladium quarterly price performance

Natural Gas quarterly price performance

Natural Gas quarterly price performance

The chart below is a daily chart of Sembmarine (S51.SG), a stock listed in Singapore on the SGX. The chart from 2012 – present illustrates how I would segment the chart into quarters.

Sembmarine (daily chart) quarterly price performance since 2012

Sembmarine (daily chart) quarterly price performance since 2012

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Soh Tiong Hum is Director of TerraSeeds Market Technician Pte Ltd. TerraSeeds is a trading educator in Singapore since 2005.   Soh's Twitter account @sohtionghum was ranked #23 out of The Top 70 Twitter Accounts To Follow In 2015 by MahiFX.   Disclaimer notice: "I do not have a financial advisor's license. I am not qualified by any regulator to give financial advice. I do not know you the reader. Your investment means and motive may be different from me. My posts here are based on observations and meant for education. I am not responsible for for any consequence from your actions."
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