A simple trading approach that I use can be summarized like this:
In this first post, we’ll discuss how to find the leaders. The next post will cover all remaining steps and look at the pros & cons of this trading approach.
Buy Strong Stuff
A stock or ETF is a leader if it has relative strength (ie. it has been outperforming its peers).
Relative strength, or momentum, is the strongest anomaly in the market. Strength begets strength, and weakness begets weakness. By focusing on the leaders, a lot of our work is already cut out for us.
How do we find the leaders? There are several tools at our disposal.
SCTR rankings (link)
StockCharts.com provides a Technical Rank of US ETFs and stocks. This ranking is based on 6 indicators covering different timeframes. You can learn more about the methodology here.
Here’s what the SCTR report currently looks like:
This shows the leaders are currently in Cannabis and Clean Energy (among other sectors).
ETF Database Screener (link)
The ETFdB.com site lets you filter the universe of ETFs by:
Asset class, region, style, cap size
Share price, AUM, daily volume
Fund provider, fees
Returns, volatility, fund flows
I like to screen for non-leveraged equity ETFs with a minimum: $100M AUM, 40K daily volume and $20 price. I also select some of the main fund issuers and set a max fee of 1%. This narrows down the universe of over 2,000 ETFs down to about 300. Here’s what I get, sorted by past 1-year performance:
Similar to the SCTR rankings, this shows that the leaders are currently in Clean Energy and Disruptive Innovation.
You can download the results to Excel, where you get even more information such as beta. By adjusting past 1-year returns by beta, you are able to see the strongest ETFs that also have relatively low volatility and/or low correlation with the market. Having a portfolio of strong ETF’s in different sectors helps smooth your overall volatility.
FinViz Screener (link)
FinViz.com has a screener similar to ETFdB.com. Here you can type in a list of ETFs, apply filters, and view the leaders. Leaders can be seen in various different ways:
Performance over a certain past period (week, month, quarter, year)
Percent from 52-week high/lows (this approach will be discussed more in the next section)
A great way to visualize leaders is to plot ETF’s by their % below 52-week high (vertical axis) and gain factor above their 52-week lows (horizontal axis). I’ve done this in Excel and it looks like this:
The leaders all sit in the upper right of this chart shaded in green. Laggards are in the lower left shaded in red. When an ETF moves into the green area, you want to pay attention as it’s on the verge of a breakout. Note: Excel automatically fetches the prices so this chart is very easy to update.
I’ll end this post with some excellent books/papers that show us the amazing power of momentum investing: