The Art of Stock Selection

The latest Non-Farm Payroll figures that came out in June were much better than expected, with 287k newly added jobs compared to the 180k consensus. After the news release, the three major US indices have responded to the positive labour market outlook by staging a multi-day bull rally. Is this the start of another bull run for the US stock markets after an eighteen-month consolidation?

The latest Non-Farm Payroll figures that came out in June were much better than expected, with 287k newly added jobs compared to the 180k consensus. After the news release, the three major US indices have responded to the positive labour market outlook by staging a multi-day bull rally. Is this the start of another bull run for the US stock markets after an eighteen-month consolidation? I can’t say for sure, but whilst the markets are moving I am looking for opportunities to go with it. But this can be like finding a needle in a haystack! Let me share my process for finding opportunities with you …

To gauge the general market momentum, I focus on the three major indices – US30, SPX500 and NDAQ100. These BIG three are the most widely watched indices by traders and investors the world over. The SPX500 is the standout of the bunch as it represents the broader market perspective. By accessing the monthly charts, the SPX500 is currently leading the bull rally with a clear breakout to the all-time high while the US30 is testing the old highs and the NDAQ100 is somewhat lagging behind the other two. Based on my analysis and interpretation of the markets, it’s clear to me that the SPX500 will be the potential leader when anticipating the next bull run and the components of this index will be my top candidates to seek out trading opportunities.

The US SPX 500 has broken out to all time new highs!

The US 30 is currently testing the old highs …

The US NDAQ 100 is the laggard of the three as it has some way to go to get to the old highs around 4,700 …

The next question is how to select the best stocks out of the 500 stocks from SPX500 that offer the highest probability of a potential runner when market momentum really picks up in coming weeks/months. Thanks to the industry classifications by S&P 500, the 500 stocks are divided into 9 sectors – Consumer Discretionary, Consumer Staples, Energy, Financial, Health Care, Industrial, Materials, Technology and Utilities. By comparing the relative strength/weakness of each sector against the SPX500 index, I am able to determine which sector outperforms the index. It’s the stocks within these outperforming sectors that become the ideal candidates.

The Consumer Staples sector and the Utilities sector are the clear winners as they are both breaking out to new highs. The reaming 7 sectors are not looking as bullish at the moment.

Now that I have the top two lists of stocks to choose from (for compositions of each sector, please refer to the official S&P website). It is now a matter of scanning through these stocks and creating a watchlist of the ones that are performing as well, or, better than the sector.

A good candidate for opportunities in the Consumer discretionary sector is Colgate Palmolive. It is in an uptrend with the moving averages fanning with convergence with both MACD and RSI. This is a definitely one stock I am currently monitoring for trading opportunities. 

SCANA, a stock from the Utilities sector, is also on my watchlist as it too is in a strong uptrend with fanning moving averages. There is slight divergence with both MACD and RSI but I am not overly concerned as price is pulling back which means that the divergence is playing itself out. If / when price pulls back to the buy zone (between the 10 and 20 moving average), then it will be ripe for a trade. 

Today, I have demonstrated my top-down approach to select potential stock candidates. But this is only the first step in stock trading.  How to time the entry, how to set stop-loss and target and how to calculate the correct position size is the next step. All of these will be dictated by the rules of a trading strategy. If you would like to learn more about the trading strategies I use to trade stocks, feel free to join our complementary premium education course: The Next Generation Trader offered by CMC Markets to all live clients, check the website for details.