When you think about it, everyone wants to buy the right stocks at the right time.
That's certainly the objective of the Maximum Profit system. The only difference is, unlike many investors, we use a proven tool to do just that -- rather than merely buying a stock and hoping for the best...
To find the right stocks, I filter out micro-cap stocks, or those with a market capitalization less than $250 million. I also don't want any penny stocks, so the share price has to be greater than $5. Finally, it can't be thinly traded, which means there must be plenty of shares changing hands to provide the needed liquidity to buy and sell the stock with ease. I use volume to determine a stock's liquidity, and it must have an average daily volume greater than 75,000 over the last three months.
To identify the right time to buy, I use relative strength (RS) as my screening tool.
Not to be confused with RSI, or relative strength index (a more popular technical indicator), RS is a simple idea that is easy to understand with a sports analogy. In any game, the winner plays in a way that is relatively stronger than the loser. If you were trying to select the winner before the game started, you would probably pick the team you thought was the stronger of the two. That might be the team with more wins or the team that you believe enjoys an edge in some way for the upcoming game. That edge might result from a home-field advantage or an injury to a key player on the opposing team.Once the game starts, the team that has a stronger start is likely to win in the end. The edge that existed before the game started no longer matters because all that matters is who takes the early lead. Sports fans know this, and researchers have actually proven it. Studies have demonstrated the team that is ahead after three innings in a baseball game wins about 80% of the time. In college basketball, if a team is leading by at least eight points at halftime, they win 80% of the time.
Whether they realize it or not, many investors think of investing like a sports contest with a definite start and stop date. They do this, for example, by reviewing annual returns, which sets January 1 as a start date for the contest and December 31 as the end of the game. When we think of investing in this way, we might want to pick stocks that have had a strong start because they are likely to be the winners at the end of the contest.
Using a one-year time period for our investment horizon, the stocks that have been the biggest winners over the past six months are likely to be the biggest winners in the next six months. This is not just my opinion; it is the conclusion of research into RS.
How Traders Use It
For example, RS can be found by measuring performance over the past six months. I am just going to use one example to measure RS, but other time periods and other calculations could be used.
To find RS for 10 different stocks, we could calculate the six-month percent change in price for each stock. We would then sort these values from highest to lowest. The stock with the highest value would have the highest RS, and we could assign a RS rank of 10 to that stock. The stock with the next highest value would be assigned a RS rank of 9. This process would be repeated until the stocks with the smallest change or largest loss over the past six months is assigned a RS rank of 1.
Stocks with the highest RS ranks would be buys. We would hold them until the rank fell below some cutoff level. In this example, we might buy stocks rated 7 or higher and hold them as long they are ranked 5 or higher. Once the RS rank falls below 5, we would sell and replace the stock with the highest-ranked stock we don't already own.
The process can be applied to any number of stocks, but it would remain the same. The steps to apply RS are:
-- Calculate the recent performance
-- Sort from high to low
-- Assign ranks based on the sort
-- Buy and sell based on the ranks
Why It Matters To Traders
Numerous studies have shown that RS works to deliver market-beating results in the long term. When applied to a list of the right stocks (those with enough volume, are large enough in terms of share price and market capitalization), it should help us profit by finding the right time to earn maximum profits with those stocks.
The Maximum Profit system is the closest thing to legally "hacking" the stock market -- and it's helped us make gains of 135%, 181%, 242% and more -- all in a matter of months. And RS is one of the pillars behind our system's success -- but there's more to it than that... To know more about this powerful system and how it can work for you, watch this short video now.
(This article originally appeared on StreetAuthority.com.)