Gary Revisits His Long Strategy

I've been getting a fair amount of questions lately on my long strategy, which I have fondly named the GBS Classic. (I am sincerely hoping it's a self-fulfilling prophecy.) Therefore, I thought I'd revisit it one more time, update you on some changes I've made and give you a progress report on its 1998 performance.

The first thing you should do is go back to the archives and read through my Sept. 8 column. This will give you my rationale for why I trade this way. It also has a few "hows," and I'll elaborate on those for the remainder of this column.

The first major change, and one I alluded to in a Q&A column, but should have made clearer, is how I screen my stocks. Yes, I always look for stocks hitting new highs coming out of congestion. But I get this list by simply picking the bold-faced stocks from Investor's Business Daily under the column NYSE (or Nasdaq) Stocks with Greatest % Rise In Volume. In a tip of the hat to the fundamentalists, these stocks are all above the 80th percentile in earnings, and though I don't care about a stock's fundamentals, these seem to hold up better when the market gets rough. In addition, these stocks also are in the 80th percentile in relative strength, which is exactly what you want with this kind of momentum strategy.

Now there are a few nice benefits with this method of selection. One, I can generate my list without doing any computer runs, and while drinking a cup of coffee, and finishing my daughter's leftover bagel. More importantly, as the number of bold-faced stocks dry up, I have found this to be an excellent indicator that the market is rolling over. Last April, for example, my selections dwindled to zero well before the market dropped, and stayed at zero until the market started to come back. I honestly have not found a better way to gauge how well this bull market is enduring. Everyone agrees we're in rare air here, but until my candidates dramatically drop off, I'm compelled to play. This objective style makes it easy to figure out whether to be in or out.

When I look through these bold-faced stocks, I pick out only the ones that have made a 52-week high. The way the IBD charts are set up, you can do this quickly.

After you've cruised through IBD, you'll have anywhere from 10 to 20 candidates. With the market going crazy lately, I've been on the upper end of this range, but the low teens is more the norm. You then need to take this list and see if the chart indicates a breakout from congestion. A lot of your candidates will simply be stocks making higher highs and you want to avoid those. No, look for a chart like Technical Forum, someone questioned my definition of a "week," so I want to be as clear as I can. I define a week of trading as five trading days. Therefore, I want at least 30 bars between the two highs.

Regarding the volume, "heavy" means at least 50% greater than the 50-day moving average of the volume. The advantage of using the bold-faced IBD charts is that a stock has to have heavy volume to appear in this list, so that makes meeting requirement two straightforward.

After I have my final candidates, I try to get my market orders in as soon as possible. Now don't all gasp at once: That's right, I said market orders in as soon as possible. In other words, pre-market open. Now I'm well aware of all the arguments, supposed risk, foolhardiness, blah, blah, blah, regarding this practice. Trust me, though: Whether it's the stocks I pick, or the fact that they're just coming out of congestion, I have never -- over the long term -- found this to be a disadvantage. Yes, of course you'll occasionally get a big gap up and find yourself in the hole. But, this is far outweighed by the times you're in on a gap up ... and the stock never looks back. If there were a better, safer, more profitable way, I'd be the first to use it. But, I've tried them all. This is the most effective, and simplest.

To make things easy, I always order with a fixed quantity. In general, 1,000 shares, but of course, you'll want to vary this depending upon the amount of equity you have. But, whether the stock is $100 or $20, I always go in for 1,000 shares. As opposed to a fixed dollar amount, I have found this to be a simpler, and ironically more profitable, way to trade over the long term.

I generally get my fills pretty quickly, and as soon as I know the price, I put in a sell limit order. In the past, I had put this order in to be 5% greater than my fill price, with the corresponding stop loss at 7.5%. Recently, though, I have been using a straight $2 profit target and $3 loss. This is the same exact ratio, but has a number of advantages. One, I get a better overall return on each dollar, and two, I am out of the more expensive stocks and back to cash a lot quicker. This saves on margin charges and is a safer way to trade. Why these targets in general? Through my back tests and real results, I have found these to be the optimal targets for risk, reward and safety. My goal has always been to have a high win rate, but get back to cash as soon as possible with a reasonable profit. These targets enable me to do that.

And ... that's it. I just wait until either target is hit, and let the percentages work in my favor. The results this year are similar to last year: a win rate of 70%, while holding each position an average seven days. This year, though, there's one important change. My average win amount is nearly 50% higher than my average loss (on open positions -- obviously my average win amount will be less than my average loss on closed positions). Apparently, by keeping the stop loss amount fixed (as opposed to a percentage), I am able to keep the lower-priced losers long enough so that they turn into winners, while jettisoning the expensive stocks before their 7.5% debit charge breaks the bank.

Now, a few notes: I'm not an idiot (well, okay, sometimes I'm an idiot, but I'm not an idiot in this case) -- I fully realize that any long method looks great in this market. To date, I am outrunning all the averages, but not by a huge amount. Where this method shines is when the market turns, and I'm primarily in cash. But if the market keeps going straight up, I'd probably be better off in an index fund. Of course, who wouldn't?

Also, I had been limiting my picks by throwing out the low-volume stocks. But, you know what? I threw out more good ones than bad, so now I barely look at the volume traded (and for that matter the spread). About the only time I'll rule out a candidate is if it's made a huge one-day move. The attached chart of PV is a good example. I'd pass on it again, but boy, I wish I had made an exception in this case.

Finally, these rules aren't ironclad, but they're close. You will occasionally have to make a judgment call (i.e. everything looks great but it's 28 bars vs. 30 bars between highs; or the volume exceeds the moving average, but only by 30%), but the closer you stick to these parameters, the better off you'll be.

Finally, like in my day trading, I received some outside counsel, and owe a debt of gratitude to TSC reader Marsten Parker. He's been a GBS Classic follower for a while now, and has helped me greatly by thinking of, and then testing, things like stop losses, fixed dollar amounts, etc. Of course, he's using my methods more effectively than I am, so I hate his guts, but that's besides the point. Thanks, Marsten!

A spiffy ending? Here it is: I know there might be more profitable ways to trade. But for combining returns, with safety, with ease of use, this is a pretty good way to go. And it leaves you plenty of free time during the day. Trust me, after wading through numerous methodologies and techniques, it's good to fall back on the old "classic" and let it churn out the returns.

*****

Alert! Alert! Danger Will Robinson!! On Thursday, March 26, AB Watley was down again. Hard down. In computer-ese, that means it wasn't a glitch and when you called they were clueless as to when they were going to be back up. Normally, I would write this off as a momentary lapse. Unfortunately, this was the second time this week, and probably the sixth time in the last 30 days they've had THE SAME PROBLEM!! Sorry, guys, you're advertising like crazy, but you're just not keeping up your end of the bargain. I know full well my columns have steered a lot of business your way. So now, I feel like I've let my readers down. Kicking me around is one thing, but kicking around people who follow my lead is another. Caveat emptor? Of course. But now you'll have at least one fewer paying customer in the fold.