Investopedia defines Compounding - The ability of an asset to generate earnings, which are then reinvested in order to generate their own earnings. In other words, compounding refers to generating earnings from previous earnings.

When you lay everything out on the table, this is your final goal with investing - get your money working for you.

I have many friends who took this concept and applied it to their careers to make them very successful at what they do. Realtors use it to grow their network, in return accruing listings at a faster rate over time. The more listings they have, the more sales they generate. Some of my friends in sales are making bank on sales networks they’ve spent years building and cultivating.

Coming from a programming background, one of my biggest challenges was to figure out how I could apply this concept to my career and skill set. The challenge faced by most programmers, and definitely any programmer that sticks with it for a decade or more, is the limited life for any given language. We are constantly barraged with the next great thing, we get out there and take the courses, read the books only to find in a few years there’s a better way to do task X. In short, reaching that mastery experience for any given language is challenging.

This is where the stock market comes in. Concepts that have worked 50 years ago, work today. Knowledge gained can be applied on a daily basis, now and for the rest of your life. As you accrue more knowledge and more experience, this momentum builds on itself making you a better trader and in the end compounding your assets.

Taking this a step further, focusing on earnings related trades, such as StockBee’s Episodic pivot or the Earnings thrust allows you to “compound” the knowledge gained on the day of earnings for a later trade when the stock pulls back and then continues forward.

Let’s break this down into the individual trades and see how you can apply this concept. We will continue to use the NFLX example discussed in earlier posts. Here is the chart for reference:

First, NFLX announces earnings and provides upward guidance on Jan 27, 2010. Being the diligent investor that you are, you review the earnings release and take note of the fact they had a 62% increase in EPS, 25% in sales. NFLX also raised guidance for 2010.

Next, the market responds overwhelmingly positive on the day of earnings with a huge volume and price surge. Wait a minute, at some point we had a discussion over at the Stockbee site about the fact that larger float stocks tend to pullback after announcements so you sit and wait a few days before entering.

In early April, NFLX signals a break-out after moving sidways for five days. At this point you already know several things:

1. The stock had great earnings back in January,
2. They also raised guidance,
3. The stock has been steadily moving up since then,
4. The sector is in the top 5 performing sectors at the moment,
5. The market is currently in an uptrend, (Beginning of April it was)

What did you need to do to acquire this knowledge? Nada, this was knowledge gained back in January and the past few months while watching the stock go up. The stock has already been on your radar for months. At this point, to make a decision to buy or pass on the signal takes minimal effort from you.

Compare this to trading diverging strategies where you would have to do a lot more grunt work for each trade to get to the ultimate decision of buy or pass. Most, if not all of your leg work was done up front so the decision process can occur much faster.

In summary, a good way to compound your knowledge is to look for strategies that pair together. This allows you to make quicker decisions with more confidence when it’s time to push the buy button.

When we enter correction phases of the market, I try to keep busy building new screens and catch up on my reading. It's a good way to learn new concepts and keep out of trouble. I just wrapped up The Complete Guide to Market Breadth Indicators by Greg Morris, and after the past few days I felt like this would be a good topic to discuss.

Draw downs are the bane of any swing trader's existence. How many times have you spent weeks or months building up your account only to have it quickly snatched away when the market turns to the downside? I know I've been there...many times.  It wasn't until I finally had a clear understanding of how these indicators worked that I started seeing significant long term returns in my accounts.

Market breadth indicators measure the underlying currents of the market for any given period, quantifying the underlying strength or weakness in the current move. A model will consist of one or many market breadth indicators to signal a entry or exit condition.

---Disclaimer: I do not receive any compensation from the sites, books, or other resources mentioned on this site. I am currently an active member of Stockbee.---

Currently, I use Stockbee's Market Monitor designed by Pradeep Bonde for my entry and exit signals. Following the Market Monitor I went into cash on 4/28 and have been SOH (Sitting On my Hands) for the past few weeks. Along with many of the other members, we have been waiting for the entry signal which has yet to happen. Last week 5/27, the secondary indicator signaled positive, but we did not get a confirmation on the primary signal so many members remained in cash. A few of us took some smaller teaser positions only to get smack down on Friday.

I have been using the Market Monitor for over three years now and have successfully avoided all of the large drops we have experienced since 2007. Additionally, I used the Market Monitor signals to manage both my trading and retirement accounts. Back in March 2009, I moved all of my accounts back into the market and pretty much doubled them over the next year.

A detailed description on how the Market Monitor works can be found at:
http://stockbee.blogspot.com/2010/05/if-you-want-to-avoid-market-surprises.html

Investor's Business Daily provides the "Big Picture" which offers a proprietary system where they notify readers if the market is in a confirmed uptrend, under pressure, or market in correction. This excerpt from their site details the concept of "Follow-Through Day"


System developed by William J. O'Neil to identify an important change in general market direction from a definite downtrend to a new uptrend. From the beginning of any attempted rally during a definite downtrend, a 'follow-through' day is identified when the index closes up 1.7% or more for the day on a significant increase in volume from the day before. The first two or three days of a rally are normally disregarded as it has not yet proven it will succeed and 'follow-through' with power and conviction. 'Follow-through' days therefore generally occur the fourth through seventh day of the attempted rally. They serve as a confirmation that the market has really changed direction and is in a new uptrend

Mark Minervini  has taken the IBD model and modified it with some of his own custom components. He normally posts weekly updates accessible to the public discussing his market timing model.

So far, I have been very happy with the Stockbee Market Monitor. I have spent the past three years mastering it and would rather focus my energy on building better watch lists than trying to reinvent the wheel.  Over the next few weeks, I will try to script out some of the indicators from the book and make them available via StockFinder.

In summary, if you want to be successful in the market, you need to start with a mechanism to tell you when to be in and when to be out. I highly recommend reviewing any/all of these sites to get a better understanding of the timing models available out there. You can use these models for your trading accounts and also your retirement accounts.

You will notice that we have added three columns to the end of this sheet:

30DayChg - 30 Day growth for this stock. If it is under 10% the cell will appear in green. Above 10% red. When swing trading momentum, it is critical that you buy the stock coming off of weakness versus the middle or even worse, the end of a move. The closer to support your purchase, the less risk you have on the table. I should clarify you are buying weakness off of a strong prior uptrend. We are not  bottom feeding!

cPct - Today's percent change. Again, we highlight the cell if the stock is up 2% or more for the day. This combined with the volume surge column will give you a good idea that the stock might be making a continuation thrust. A Continuation Thrust means the stock has an upward trajectory but has recently taken some time to consolidate and is now continuing with the move.

VSrg - This column tells you the change in volume over the average volume for a given period. The more volume, the more interest there is in the stock.

OK, let's be very clear - because all of these columns are flagged in green DOES NOT mean this is necessarily a buy signal. If it were only that simple, right! What this does tell you is there is interest in the stock, and this stock has been historically outperforming a good majority of all other stocks.

At this point, you can click the "Chart" link to view the chart over at stockcharts.com. I think a monthly subscription runs around $14.00 per month, fairly reasonable for what you get. (I do not receive any fees from stockcharts.com or any other service that I happen to mention on this site).

[edit June 6, 2010 - another reader suggest FinViz.com, FreeStockCharts.com for free charting software. Thanks for the recommendation.]



In the case of NFLX, you get to see the entire set of trades. First it starts out with an Earnings Thrust on Jan. 27, 2010 "Netflix, Inc. Issues Q2 2010 Guidance In Line With Analysts' Estimates; Raises FY 2010 Guidance". It follows through on the earnings thrust and rallies for 7 weeks before moving sideways for a week. Then on April 5th, NFLX displays a Continuation Thrust with a new 5 day high on above average volume after a sideways move. I'm not going to get into stops because that is a very long topic in itself but if we were using an pSAR stop, you would have been out at a close price of 85.31 on April 16.

If you're interested in the different types of chart patterns; How Charts Can Help You in the Stock Market by William L. Jiler is a good reference. Chapter 6: Line and Saucer Formations and Chapter 10 Continuation Patterns seem to be the sections I often refer back to read.

 Trading Tools - When you get to the point where you feel comfortable in the market and want to throw some money at your tools, you have several options out there: Telechart, StockFinder, Tradestation, Ninja Trader, Think or Swim etc. BEWARE - These tools while handy can also add to your noise level as you constantly mess with different indicators!

Recently, I have started looking at StockFinder since it uses an extension of the .NET programming language which I have intimate knowledge. So, if we take the same setup as before NFLX and drop that in StockFinder you get the following result:


Stockfinder gives you some handy options where you can drag and drop or script out criteria (similar to PCF scans in Telechart). The arrows and orange highlighted bars match the criteria in my scan so they are automatically flagged on the chart.

To get the watchlist from our Google spreadsheet to StockFinder, simply create a new Watchlist in stockfinder named "Top Stocks with Price and Sector Momentum". Next select all the cells in the Symbol column in the Google Spreadsheet and Copy them (Ctrl + C). Finally, right click in the StockFinder watchlist pane and select "Paste" from the menu. Voila! You can now monitor the stocks using Stock Finder. By clicking the PF_BreakOut scan in the chart pane, all stocks in the top 50 watchlist will be scanned for any matching the criteria.

You should be able to download by default layout in StockFinder by going to "Share" in the top menu. Then select "Browse other users shared items" and then scroll down by name "PatientFisherman_Default". The password is "momentum". This is a work in progress so the layout will be influx for an indefinite amount of time.

In summary, you can use our Watchlists to narrow your stocks down to the best stocks with highest momentum weighted against sector and value. Then, you can use the Google spreadsheets to actively find stocks signaling a Continuation Thrust. Finally, you can review the stock's setup by using tools such as stockcharts.com or stockfinder to make a final decision.


Other Resources:
Research Papers:
Hwang, Chuan-Yang and George, Thomas J., The 52-Week High and Momentum Investing. Journal of Finance, Vol. 59, No. 5, pp. 2145-2176. Available at SSRN: http://ssrn.com/abstract=1104491


Chen, Hong-Yi, Chen, Sheng-Syan, Hsin, Chin-Wen and Lee, Cheng-Few, Price, Earnings, and Revenue Momentum Strategies (March 15, 2010). Available at SSRN: http://ssrn.com/abstract=1571883


Books:
Smarter INvesting in Any Economy: The Definitive Guide to RElative Strength Investing - Michael J. Carr

For a swing trader, trading should not be filled with many emotional highs and lows in any given period. Twenty four hour news has turned investing into this fast paced, fast money, news flash circus ring.  If you're feeling frantic and riding an emotional roller coaster daily, you need to rethink your strategy. It's not about the big win, it's about building on many small wins. You have your routine:

1. You review and maintain watch lists
2. You scan for setups
3. You enter the stock at a proper buy point
4. You exit when you get an exit signal
5. Rinse and repeat.

You do this over and over and over.  As your account grows, you just keep building on those gains day after day, month after month and year after year. Stop thinking every stock you buy will go up 1000 percent, build a routine and focus on growing your account and compounding those gains.