Using overall market health to time stock screens

Parker from Texas sent me his ideas on selectively going long with AAII stock screens:

AAII stock screens are long-only. Which is great in uptrends. And spotty in downtrends. So, I fooled around and came up with a screen which tells me when to use the AAII screens. Here it is - one simple question:

On the monthly chart, did the S&P close above its 12 month simple moving average? If yes, use the AAII screens for the next month. If no, sit out or short the market. Here’s a chart:

Using this method, you would have gotten the signal to go long on 11/1/98 and get out 10/31/00. Here's how selected AAII screens fared over that 24 month period:

Zweig = +103.8% (~43% per year)
CANSLIM = +117.1%
Est Rev Up 5% = +243.9%
Tiny Titans = +133.3%

Note - the S&P went from ~1100 to ~1425 in this period, a 29.5% gain (~14% a year).

The next buy signal was on May 1, 2003 and lasted until 12/31/07. Here's the cumulative performance over 4 years, 8 months, re-balancing and reinvesting every month:

Zweig = +362.2% (~39% a year)
CANSLIM = +199.0%
Est Rev Up 5% = +350.5%
Tiny Titans = +381.2%

Note, the S&P went from ~910 to ~1460 during this time, a gain of 60.4% (~11% a year).

Had you shorted the S&P on 11/1/00 at ~1425, you would have covered at ~910 on April 30, 2003, picking up a nice profit while you wait to implement the screens again.

Under the same principles, you would have shorted on ~1460 on Jan 1, 2008 and be sitting pretty with the S&P at 860 right now.

So there you have it - a simple 12 month moving average screen on the screens. Unfortunately, it may be awhile before the S&P closes above its 12 month average.

To The Moon Laid To Rest

I've tracked my To the Moon screen for a few years now and it's time to let it go. My intent in creating the screen was to show that even a simpleton like myself could put together a winning screen if it was followed without emotion. Since September of 2005 the screen has made over 300% compounded.

The screen was made up of the highest Relative Strength stocks in four different screens I ran. One screen was AAII's Zweig screen and the other three were Screens from Zacks Research Wizard. I just took the highest Relative Strength stock of these three screens:

bt sow best buys
bt sow big money
bt sow filtered zacks

This was a "buy on Monday sell on Friday" stock screen that did very well in a pretty lame market. I wanted to show that there are opportunities in the market for individual traders who don't have a lot of time and who don't want to have to monitor the market on a consistent basis.

My subscription to Research Wizard runs out this summer and I don't intend to renew. I think Research Wizard is a great product, but for me it is too pricey and I don't like that it doesn't have an established community of users who share ideas and information.

I will continue to use AAII's Stock Investor Pro as I work on new ideas while following the simple screens that I've been watching for the last several years.

AAII Stock Screens

Most of you know that I cut my teeth on AAII's Stock Screens. I have been following them for several years and I love their simplicity. Moneysuckle (of the complicated poker post) has put together some information on why he has chosen just a few screens among the several that AAII shares each month. The results he discusses are assuming monthly re-balancing and holding all stocks that qualify in the screen.

Buffet averaged 25-30% a year compounded to amass his fortune. Of course, he dodged a lot of taxes with his buy and hold strategy. I cite this as a baseline to judge the AAII screens.

In order to get a total (pre-tax) return of 1000% over 10 years, you need to average 26% a year. A 1500% return over 10 years is 39% compounded per year. A 2000% 10-year return is 50% per year compounded.

So, when I look at the AAII screens, I am looking for anything with a total return of 1000% or more since 1998 - or returns Buffet would be happy with. I know, of course, that I'll likely be paying 28% cap gains tax on my profits, so I need as much cushion as possible.

The other things I am looking for in these screen results:

1. Consistency in returns. If a screen has a 1200% total return, but has 6 winning years and 4 losing years, that's not as attractive to me as a 1200% screen with 9 winning years and 1 losing year. When a screen has a big return but several losing years, it implies that it is not suitable for use in all market conditions.

2. No horrible years. I consider a horrible year a double digit loser.

3. Emphasis on recent performance. If a screen has a great total return, but 1998-1999 played a big role in it and recently it hasn't done as well, I will downgrade the screen.

4. 15 or less qualifying stocks on average. I don't want to invest in more than 20 positions at a time, and I am really interested in 6-12 positions at a time. Therefore, a screen that gives me 45 qualifying stocks on average is of marginal use. Further, if I think I can screen the screen (like with Zacks rankings), then the more stocks I am screening out with Zacks, the more the AAII total return % becomes meaningless since I am doing something completely different than AAII did. Finally, if I invest the same in each stock, if I use a screen that produces 45 stocks and 1 that produces 15, I will end up weighting the 45 screen more. Which is probably bad since Zweig and CANSLIM have the best results, and they produce fewer stocks.

With that in mind, let's examine the candidates.

Currently, Graham Enterprising Investor is at 923%. It produces 4 qualifying stocks per month. It lost money in 1998 and 1999. While the losses were small (single digit), the market had great years in 1998 and 1999. Thus, this screen vastly underperformed the market in those years. It has vastly outperformed the market since. In fact, from 2000-2007, it's total return is 1109% (which is over 50% per year compounded for 8 years!!). This tells me that the screen works well in periods when fundamentals matter. Fundamentals didn't matter much in 1998-99 - it was mania. Finally, the screen is up this year! I will use this screen for current market conditions.

Foolish Small Cap 8 Revised - 623.1%. Through 2007, this screen was very impressive at nearly 1000% 10-year total return. Plus, it had 9 winning years in 10. It's only loss was small (3.9% in 2004). Otherwise, it made at least 12% every year. Very consistent. Plus, it produces only 7 passing stocks a month on average. However, this year, it is down 35%. Until I can figure out what's going on, I am not planning on using this screen. I am going to keep an eye on it, however.

O'Shaughnessy Growth - 652%. Another very consistent screen. 10 straight winning years of at least 10% gains. Until this year (down 13%). But it produces 50 stocks per month. Not suitable for my purposes, but I will watch it.

O'Shaughnessy Small Cap Growth & Value 985% - Another impressive screen. 9 excellent years and flat in 2002. But it's losing this year (down 13%). Plus it produces 25 stocks a month. Not suitable for my purposes, but I will watch it.

O'Shaughnessy Tiny Titans - 2262%. Awesome total return. But poor recent performance. $100 invested in Jan 2005 would be $114 today. Clearly, the weakening dollar has helped the larger companies recently (who have international operations) at the expense of small domestic companies. This may explain the drop off in performance. Plus, it produces 25 stocks a month - too many for my purposes.

Value on the Move - PEG with Est Growth - 833%. Another 1000% winner with 10 straight winning years until 2008 (down 15%). After a poor 1998-99, it made 970% from 2000-2007 or 49% compounded, which is incredible. But it produces an average of 47 stocks a month. Not suitable for my current purposes.

Zweig - 2107%. By far the best, most consistent screen on AAII from 1998-2007. Never returned less than 17% a year. 10 straight winning years in all sorts of market conditions. Until this year. I am willing to forgive it 2008 (down 12%). I am also willing to forgive the "slowdown" from 2005-07 when it "only" earned 18-27% a year. However, I am keeping my eye on Zweig to make sure it doesn't go south on me. Produces 15 stocks a month on average, in my sweet spot. I will use Zweig.

CANSLIM - 1471%. Excellent total return. Very consistent. 9 winning years of at least 20% a year vs. 1 modest losing year (3.8% in 2004). All on 9 stocks a month. Down only 3% this year, which beats the market. My second favorite screen behind Zweig. I will use CANSLIM

Est Rev Up 5% - 1302%. Excellent total return, but got a huge boost in 1998-99. This screen focuses on positive earning surprises, and everyone was buying/selling on news (instead of fundamentals) back in 98-99. Still, had excellent years in 2003-07. But it produces 43 stocks a month. Plus, when I cross-screen Zweig and CANSLIM through Zacks, I get stocks with good earnings surprises. As you might imagine, more of the Est Rev up 5% stocks get 1 ranks in Zacks than Zweig stocks do. So, if I used this screen, I'd be heavily diluting Zweig. I will watch it, but I don't plan to use it.

So, there's my analysis of the screens. I will focus on Zweig, CANSLIM and Graham Enterprising, which should produce a combined ~30 stocks a month. Edited for Zacks 1-2 ranks, that will bring it down to a manageable 6-12 stocks a month.

I plan to fully invest my portfolio each week, and invest in each stock equally. So, at 1% risk, 12 stocks means I need to put a 12% stop loss on, and 6 stocks means I need to put a 6% stop loss on. I saw your 2007 stats. For Zacks 1 + Zweig, your average loss as -3.2% on your losing trades. Therefore, I'd think a 6% stop loss is way sufficient. Unless you had a lot of experience with stocks losing more than 6% off the bat and coming back to be winners. Which I doubt.

Theses are the types of stats that I love to gather for myself. I think that thinking through issues like these often make you a much better trader. I know it has helped me put together my own ideas, and has helped me tremendously during periods of drawdowns.

Week in Review 2-1-2008

I got spanked.

This week was a mess for me and it is reflected in my account. I didn't lose anything (I gained a measly .5 percent), but when the averages looked like this (Dow +4.39%, the S&P 500 +4.87%, Nasdaq +3.75%, and the Russell 2000 +6.08%) I can't be too happy about my performance.

Here's where I went wrong (please learn from my stupidity):

• I lost focus and strayed from my plan
• I resorted to stops (and had no guidelines for how to place them)
• I paid too much attention to indicators, news, and other blogs which paralyzed my trading
• I worried too much about the broad market
• I waited for stocks to "prove" themselves and then got left behind as they rocketed upward
• I sold too soon

It has never paid off for me to market time, and yet I do it every time my account takes a hit. You'd think after years of doing this, I would learn my lesson. It just hurts so much to loose money even when you know it's all part of the game.

Now that January is over, I hope to get back to the plan and crawl out of this hole I've dug for myself.

All but one of the stock screens did very well this week. The ZZ#1 screen which filters AAII's Zweig screen with Zacks #1 ratings made 11.42% this week with it's one pick LXU. That is the first stock the screen has picked since the end of December which may be an indicator of its own (no #1 stocks--market sucks).

The Zweig Relative Strength screen made 4.05% this week but is still underwater for the year. The screen would have done much better if it wasn't for the blowup of GHM at the beginning of the week. I picked GHM up on Wednesday and have made a nice 13% on it so far which was my only good call this week. Without GHM the screen would have made over 10% this week thanks to a tidy 29% return for WSCI.

StockPunk's To The Moon screen is sucking wind and is down over 11% for the year so far.

I guess it could be worse . . .

I lost .76% today. Why didn't I just stay in cash?

In the last two weeks I've lost 5% of my portfolio. That hurts, but the S & P 500 is down nearly 6% which is two percent more than it made last year.

So when I look at the big picture, things could be so much worse. In November I lost over 15% in 3 days. I think I learned a bit from my failures last year and I hope that I am trading a bit better. I just need some more patience.

Kirk has a good article on AAII screen performance. He detailed it much better than I could have.

AAII Stock Screens

Most of you know that I love AAII's stock screening ideas and that I have focused on the Zweig screen since 2005. The site hasn't reported year-end numbers for the screens yet, but there are some interesting things to note for 2007.

November 2007 was one of the worst months for the AAII stock screens since they started tracking the returns in 1998. It's comforting to know that some of the difficulties we faced as traders in 2007 were felt far and wide.

Many of the screens that consistently out-perform the market struggled this year. Others that haven't really kept up over the years had banner years.

AAII provides an excellent spreadsheet that details every screen with monthly returns, turnover, average number of stock picks, and cumulative return. It is worth spending several hours on their site and soaking in some of the knowledge and experience that they offer.

Changes to StockPunk for 2008

In the next couple of weeks, I'll be detailing changes that I'll be making to the site over the next year.

Here are a couple--

Weekly Stock Screens--
During 2007 I posted stocks that passed my screens on a weekly basis. I did this to allow folks to follow the screens and to show that the screens can produce real returns.

This year I will only post stocks that I come up with on my own. I will still post the returns of some of my favorite screens, but I will not post the actual stocks that show up each week. If you are interested in finding out which stocks qualify, you'll need to use AAII's Stock Investor Pro and/or Zack's Rankings.

StockPunk's Market Meter--
During 2007, I learned a lot about determining the overall direction of the market as a whole. I plan to use StockPunk's Market Meter to allow StockPunk readers to see my opinion on market direction on a daily basis.

Another Goal Met . . .

Another goal I had this year was to beat the Stock Superstars service which is a investing newsletter provided (for a fee) by The American Association of Individual Investors (AAII).

I followed the newsletter's advice in 2004 as a new trader and learned a lot about investing and fundamental stock picking.

The service is run by some very smart and seasoned investors who are very transparent in their strategies and performance (a rare combination).

So far this year, the service has made 6.8%--another confirmation that this was a very difficult year to be an investor.

Rick writes:

I stumbled across your blog site about your investing experiences and was intrigued by your methods. I have been buying/selling stocks and funds for close to 10 years now. I never really spent much time researching or really trying to make any money. My first round was with DRIP's and although I only made about 5-6% it was fun. I then moved to funds and typically made about 10-12% a year and at the same time I dabbled with stocks. I almost always ended up losing money with stocks.

After a couple years away from stocks, I decided to get back at it. This time around I am taking it serious and I am going to learn what I am doing before buying anything and try to make very educated decisions. I am a member of Zack's Premium, as well as a couple other sites, and I am starting to get more comfortable with the screens and started to build some of my own custom screens. I haven't paid much attention to AAII's site until I came across your blog.

I am interested in why you like the AAII site so much, what do you gain from it that is better/different than what I can get either free from other sites or from Zack's? Any advice you could offer?

Also, thank you for recommending Kirk's report, it is a Gem that I never came across before.

My Reply:

Thanks for sharing some of your experience, Rick. I am always fascinated to see what other people are doing because there are a million ways out there to work the market!

Here's why I like AAII.

1. It's cheap compared to most sites. I was a member of just the site for a few years. At $40 a year, that was a bargain. I learned a bunch each month and I really cut my teeth on AAII's risk management and stock screening.
2. They're honest. Most sites "cook the books" a bit to make themselves look better than they really are. Just look at Hulbert's Financial Digest (I recommend subscribing) and you can see how inflated nearly every newsletter or service makes their returns. I subscribed to AAII's Stock Superstars Report for a couple of years, and I was extremely impressed with how accurately information was reported. The same goes for their stock screens. I've tracked them myself to confirm the numbers (because some of them are hard to believe) and have always found them to be accurate. I haven't found many other stock sites that are like that.
3. The screens have nearly 10 years of data. AAII's stock screening started in 1998 which is years before I got into the game. In their screening area they track performance on a monthly basis. I've been hard pressed to find any other site that provides that type of information.
4. I like other members of AAII. I went to a local meeting of AAII members and I was the youngest guy there (I'm 40). It looked like a room of Warren Buffets. And they asked questions like Warren Buffet. There weren't any "hot shots" that tried to dazzle with their revolutionary techniques.

I've found that Zacks shares many of those attributes. The site has shared an enormous amount of information for free over the years (they just started charging for Premium) and for the most part, they avoid sensationalism.

I'm always looking for alternatives. I have an irrational fear that AAII will close shop and my sources for information will dry up. So I would like to have a couple of backup sources for data eventually.

jt writes:

Hi:

sorry to be such a pest but i would like to ask one more question concerning your process. What software do you use to test and what is your source of data? You also mention testing back from January 2003 (in your recent post about using RS as a filter. Have you ever tested your strategies under different conditions (between 2000-2002 for example?)

My reply:

I use AAII's Stock Investor Pro for both the screening and data. The service provides new numbers each week and I've been real happy with value that AAII provides.

I started following AAII's screens in 2003 (I had no idea what I was doing back then and some would argue that I still don't). My own modifications came just a couple of years ago. I have searched far and wide for a way to backtest my ideas but everything I've come across is too expensive or cumbersome. If anyone out there has some good ideas on backtesting please let me know!

Here's one of the e-mails I received today:

I've been a Kirk reader for some time and have learned a lot from his stuff. He's what pointed me to your blog, which I found interesting, informative and amusing. Also, your 2006/2007 performance is very impressive.

As a Zacks Elite subscriber, I too use Zacks Rank with my screens. You mentioned you use Zacks with the AAII Zweig screen to boost performance. Now you've convinced me to join AAII, which I knew about but had never joined.

Would you mind sharing with me the details of how you rebalance weekly? Traders have differing methods for rebalancing, and I'm always interested in learning how successful traders manage their trades. Thanks.

My reply--

Thanks for your e-mail and your encouraging comments. I’m glad you found some things amusing. Sometimes I have no idea what I am doing and I think it is good to communicate that. The only thing that I can’t figure out about my performance is why an idiot like me can earn that much when there are much smarter folks out there who struggle to beat the market. It worries me sometimes that I have just been lucky the last couple of years and that I really am just a dweeb that doesn’t have a clue.

Zacks has a really cool stock screener called Research Wizard (you’re probably familiar with it). I’ve done the 2 week trial a couple of times and I like it, but I haven’t been able to justify the $1,000 per year price tag yet. I think I would be very interested if I could seamlessly incorporate AAII’s screens into Zack's screener. I use AAII’s Stock Investor Pro which costs around $200 per year.

I really don’t have a tried and true system for rebalancing. I don’t actually rebalance each week. I re-evaluate my holdings each week. I heavily emphasize stocks that match the Zweig screen, Can Slim Screen, and a few of the others and then filter the stocks with Zack’s #1 ranking. I hold around 5 stocks until something changes—either the stock no longer appears on the screens or it loses it’s Zacks ranking. (If the ranking changes from a “1” to a “2” I might tighten my stops a bit, but not much. If it changes to a “3” it’s over for the stock and I put a 3 percent trailing stop on it.) That’s pretty much it. Nothing too complicated.

Using Zacks Rating with my screens

One of my top ten books for trading is Ahead of the Market by Mitch Zacks. Despite its shameless promotion of the Zacks website and ratings (who could blame him), the book is very helpful in showing some market moving concepts. The Zacks rank is a great tool. It rates stocks based on earnings surprise (which is explained very plainly and thoroughly in the book) which over time seems to be a good indicator of short term movement. The earnings surprise screen on AAII has produced gains of 1165.2% since 1998 which isn't too shabby.

I've been combining the Zacks indicator with some of my screens for nearly two years and the results have been pretty impressive. For example, since September of 2005 the combination of Zacks ranking and AAII's Zweig screen has made over 100% in gains while the Zweig screen alone has made about 23% during the same period. So far, picking just the stocks that rate a "1" on Zacks and rebalancing weekly seems to really boost the performance of a very profitable screen.