Screening to Win: The Value Trap

One of the issues with trading the “Value Trap” many traditional fundamental investors fall into. Many investors buy into a stock because it appears cheap, only to watch it decline in value. At the stock drops further it looks cheaper, and the investor attempts to average in and buy even more shares because it now looks even cheaper. “If you liked it at $30 then you are going to love it $20,” goes the old expression.

Many investors screen simply on valuation criteria attempting to find stocks that look “cheap”. If the P/E, P/B, and other factors look good compared to other companies in the same industry then the stock is “on sale”; which is an invitation to hit the “buy” button. Warren Buffet and others talk about value, and many small investors attempt to imitate their “style”. However most of the institutional big boys are normally selling their portfolio about the same time smaller valuation investors are looking to buy in.

The problem with most value driven purchases for individual investors is that 70% of them do not pan out; the bulk of these failures incur significant losses. Most investors do not mine gems in their fundamental searches, instead they are digging up the debris from the discard heap. Many of these stocks are cheap for a reason, the reality is that they are either declining industries, are poorly managed, or are facing business challenges. The stocks hyped in the financial press as value plays are often the worst examples. Despite screening for both forward and backward fundamental ratios; many times the underlying problems are not apparent to value investors.

What are these investors missing?

The primary attribute the investor is forgetting about is price action when screening the universe of stocks. Simply scanning for “cheap” leads to a pile of probable losers. There is normally a reason a stock is a “value play”; in the same way there is a justification of why a used Yugo costs less than a Mercedes.

Investors need to take a firm look at price action as part of their valuation analysis; this means having a compete understanding of charting, technical analysis, and relative strength. In the example above, any basic analysis of moving averages, relative strength of Citi compared to other financial stocks, or evaluation of the chart would have quickly revealed that Citi was doomed during this time period – despite an “appealing valuation” at multiple points.

In order to avoid the 70% of the stocks in the scrap heap, value investors need to screen for more than just fundamental factors as part of their overall evaluation of candidates. The Hingefire stock screener provides a tool that supports evaluation on multiple fundamental and technical criteria which helps put the market edge in the corner of investors.

CSCO: Rising Expectations

Cisco stock has risen over the past days in expectation of the upcoming earnings announcement on Tuesday (May 6th). CSCO has a habit of rising into the quarterly report then sinking in after-hours trading during the middle of the call when forward guidance is provided. One can only hope that in midst of a fairly dismal earnings season that the guidance provided by CEO John Chambers outlines an expected rebound in U.S. IT spending for the remainder of 2008. Otherwise history may once again repeat itself.

Cisco is expected to report earnings of 36 cents on revenue of $9.74 billion, compared with 34 cents a share on revenue of $8.9 billion for the year-earlier period. Guidance has been provided for a 10% growth in revenue for the quarter in an uncertain macro environment. Analysts will look to the company’s comments as a barometer on the tech industry. [note: corrected]

CSCO stock has been showing strength over the past few weeks. Any type of quantitative analysis now shows that the probability of the stock going to $30 is greater than sinking to $20. This is positive news for Cisco bulls. However many are left wondering if the current price action is reflective of the traditional pre-earnings rise or if the stock is building a base for significant increases over the coming year.

The charts of CSCO provided below reflect the support floor at $22.80, and improving technicals. The stock has risen above its 50 day moving average and is approaching the 200 day moving average with increasing volume over the past days. RSI has increased from under 30 in mid-January to nearly 70 today reflecting the relative strength of the stock. The MACD indicator is above both the zero line and signal line, and appears bullish as the gap above the signal line is accelerating. Chaikin Money Flow (CMF) has turned positive as more money as flowed into CSCO stock over the past few weeks.


Of course, the quarterly earning report at Cisco always tends to throw a wrench into the technical evaluation of CSCO stock.

Fundamentally Cisco is still a cash generation machine. However institutional investors want to see the cash put to work in the form of large sized acquisitions or a dividend. Don’t hold your breath waiting for a dividend, but further sizable acquisitions that drive growth are likely given the history of the company. Investors hope for some meaningful insight about the company’s growth plans.

Investors are looking for something new to spark their enthusiasm for Cisco stock, otherwise most will simply hold their existing shares while listening to CNBC commentators muttering the now traditional quote, “Love the company, hate the stock” – and praying that the next quarter will bring some new magic.


Disclosure: Author holds CSCO long.

The TED Spread

The TED Spread is the difference between U.S. Treasury bill yields and yields for Euro deposit contracts of the same maturity as represented by LIBOR. The name derives from "T-Bill" and "ED” (the ticker symbol for the Eurodollar futures contract). The TED spread is used as a measure of investor confidence and is considered to be a leading indicator of stock market performance.

Originally the TED spread was the difference between the interest rate for the three month U.S. Treasuries is contract and three month Eurodollars contract. Since the Chicago Mercantile Exchange (CME) dropped the T-bill futures, the TED spread is now calculated as the difference between the T-bill interest rate and LIBOR.

The TED spread acts as a measure of credit risk and represents the flow of dollars into and out of the U.S. An increasing TED spread indicates increasing risk, while a decreasing spread signifies decreasing risk. A sudden widening of the TED spread demonstrates a flight to quality, and is indicative of a market under stress.

A recent chart of the TED spread demonstrates the spikes above the 1.5 level which has historically preceded some declines in the stock market. The sudden increase and extreme volatility of the spread shows a market under stress from the subprime credit issues. The spike in the TED spread in late 2007 preceded the January market slide; staging a scenario where the spread acted as a leading indicator to the decline of the stock market.

A chart of VIX during the same period shows strong volatility at the readings bounced between 16 and 31, but was less effective in acting as a leading indicator for the market decline. VIX tended to track rather than lead the market. Once example is the rise of VIX from 18 to 31 in early January which is virtually in lock-step with the market drop.

Does the Ted spread always act as a leading indicator of an impending market decline if the level rises above 1.5; according to Bespoke the historical record does not demonstrate this strong correlation. It is more important to focus on the volatility and direction of the TED spread as a leading indicator. Huge volatility and a rapid rise to a high level is a more solid leading indicator of credit stress that would lead to a stock market drop than slow changes in the TED spread.

When evaluating market conditions, it makes sense to pay attention to the TED spread. Many times it serves as a much more effective leading alarm than VIX in revealing the potential for downside risk.

On the positive side, the recent decrease of the TED spread to below one is indicative of improving credit conditions and is a green light for stock investors. However with credit conditions deteriorating in other debt sectors (Munis, auto, credit card); investors should watch for rapid changes in the spread which would serve as a warning flag of possible further stock market declines in 2008.

Screening to Win: Williams %R

The overview below describes one of the common technical indicators – Williams %R and provides insights on how to utilize it in your stock selection. Hopefully this outline will provide traditional fundamental investors with some solid insight on how to incorporate technical indicators into their screening. The free HingeFire Stock Screener which can be found at http://www.hingefire.com is one of the few tools available that includes a wide selection of fundamental and technical criteria for selecting stocks. Using a combination of fundamental and technical screening is a powerful tool for winning in the market.

Williams %R

Williams %R Overview

The Williams %R was created by Larry Williams, and is useful for identifying overbought and oversold conditions in the market. The indicator shows the relationship of the current close in relation to the high-low range over a fourteen day period of time

Values above 80 are considered oversold while values below 20 are considered overbought. Note that this is the exact opposite of most oscillators that utilize a scale of 0 to 100.

The Williams %R Indicator is normally plotted inversely with 100 at the bottom and 0 at the top of the vertical axis. This is reverse of most oscillator graphs. Some charts present the indicator as running from -100 to 0

By the nature of its formation, the Williams %R indicator is generally quite choppy and active. Many times it will provide false signals, which is why investors should look for confirmation from charts or other indicators before entering a transaction.

The HingeFire tool provides support to incorporate Williams %R in your creation of screens for stocks. Users can scan to determine if the Williams indicator is greater than or less than the key 20 (overbought) and 80 (oversold) levels, and also establish if the Williams %R value has just crossed above (JCA) or below (JCB) these thresholds.

How to use Williams %R in screening

Most investors utilize the crossovers from Overbought and Oversold conditions when screening with the Williams %R indicator. Unlike other oscillators, many times crossing into an extreme is of interest rather then just crossing out of it.

Many times the Williams indicator demonstrates price pressure on the edge of an extreme leading to a cycle of higher or lower prices in the direction of the prevailing trend for the period of time. This leads investors to screen for just crossing into extremes below 20 (overbought) or above 80 (oversold); as well as crossing out of these conditions.

Crossing into oversold

Stocks crossing above 80 are considered oversold with Williams %R. Many stocks cross above this threshold and continue in the direction of the prevailing trend for considerable periods of time. Many investors correlate the cross into oversold territory with other technical indicators and use the combination to gauge short-term price momentum.

MFRI (MFRI Inc.) recently crossed again into oversold territory under 80 (plotted at the bottom). The previous cross into oversold territory on October 22nd led to a significant slide in the price of the stock over several weeks. The recent crossover could be setting the table for a similar occurrence.

Crossing into overbought

Stocks crossing below the 20 threshold are considered overbought in the Williams %R indicator. Many times crossing below this level can be a sign that the price increases may continue for a several week period of time; therefore many investors screen for this occurrence.

A fairly volatile stock APFC (American Pacific Corp.) had recently crossed below the 20 level placing it in overbought territory. The earlier cross below this level at the beginning of October demonstrates that this can many times herald the start of a short-term period of price increases while Williams %R remains below the 20 threshold (plotted at the top)

Crossing out of oversold

Many times excellent opportunities exist when the Williams %R indicator crossed below the 80 threshold indicating the stock is not longer oversold. Most traders correlate this change with other technical indicators to confirm the new trend. Some investors wait until the Williams oscillator crosses the 50 mark before acting on a trend reversal. The Williams %R indicator is choppy by nature and can easily reverse after crossing below extremes which is why it is important to wait for the new trend to develop.

A recent HingeFire screen found that DRIV (Digital River Inc) has just crossed below the 80 level exiting the oversold condition. Correlation with other indicators may indicate that the new trend of increasing prices rising is likely to remain in place for several weeks.

Crossing out of overbought

Another trend reversal scenario occurs when the Williams %R indicator crossed above the 20 level indicating the stock is no longer overbought. Correlation with other technical indicators often indicates opportunities where the price is likely to continue to drop in price over a several week period. This can enable investors to time solid entry points at short term troughs in price or look at shorting scenarios.

FUQI (Fuqi International Inc.) held its IPO in November. Since this time the stock has traded in a range of $6 to $11.50. Recently the Williams %R crossed above the 20 threshold exiting the overbought condition. Since this time the price of the stock has dropped by more then two dollars.

Williams Summary

Williams is similar to the stochastic indicator, however the 14 days Williams %R tends to be more choppy. This leads at times to false signals regarding trend reversals and breakouts; on the positive side the Williams indicator tends to be quick and does not lag greatly. This all gets back to a regular theoretical discussion regarding signal quality versus speed. Overall, it is important to use other technical indicators to confirm the action in the Williams %R before performing transactions.

Many investors use a 28 day version of Williams %R in charts for a smoother version with less false alerts.

The HingeFire tool supports users in screening for the following essential situations with the Williams %R Indicator:

• Crossing into oversold – Williams crossing above 80.
• Crossing into overbought – Williams crossing below 20.
• Crossing out of oversold – Williams crossing below 80.
• Crossing out of overbought – Williams crossing above 20.

Combining indicators such as the Williams %R Index with other technical indicators enables investors to properly time entrance and exit opportunities in the market. The Williams Indicator support in the HingeFire Stock Screener combined with other fundamental and technical criteria provides a powerful tool to uncover prospects that can enhance your portfolio.

Screening to Win: MACD (Moving Average Convergence / Divergence)

The overview below describes one of the common technical indicators – MACD and provides insights on how to utilize it in your stock selection. Hopefully this outline will provide traditional fundamental investors with some solid insight on how to incorporate technical indicators into their screening. The free HingeFire Stock Screener which can be found at http://www.hingefire.com is one of the few tools available that includes a wide selection of fundamental and technical criteria for selecting stocks. Using a combination of fundamental and technical screening is a powerful tool for winning in the market.

MACD

Moving Average Convergence / Divergence Overview

The MACD indicator was originally developed by Gerald Appel, and is considered to be one of the most reliable center line oscillators. MACD is formed by taking two moving averages, and subtracting the longer timeframe moving average from the shorter. This creates a leading momentum oscillator from underlying moving average indicators which are lagging. Typically a 26 and 12 day EMA are used to form the standard MACD indicator. The selection of these periods appears to provide the best trade-off between the reliability and speed of the MACD signals.

MACD is a centered oscillator; it rises and falls below a Center Line which is the zero level. Generally, territory above the center line is deemed bullish, while the area below is considered bearish. Centered oscillators are useful for identifying strength and weakness, but not overbought or oversold extremes.

A Signal Line is created for the MACD indicator by plotting a 9 day EMA of the MACD values.
The HingeFire tool provides support to incorporate MACD in your creation of screens for stocks. Users can scan to determine if the MACD indicator is greater than or less than the Center Line or Signal Line, and also establish if the MACD value has just crossed above (JCA) or below (JCB) these thresholds.

How to use MACD in screening

Most investors use MACD to determine if the general trend is bullish or bearish for the stock. Conventionally levels above the centerline are generally considered bullish, and those below bearish. A similar situation holds for the signal line. However most investors are focused on when the MACD indicator crosses these levels indicating a change in trend. The existence of the indicator above or below these levels in itself is not viewed as conclusive regarding the trend for the stock. Most investors screen for bullish or bearish crossovers of the MACD indicator of the Center Line and/or Signal Line.

Bullish MACD Crossovers

One common bullish scenario is when the MACD indicator crosses above the Centerline (zero level). The HingeFire screener supports looking for these crossovers. A screen in late October found Abbott Labs (ABT) when the MACD indicator (blue line) crosses over the Center Line. This was shortly after Abbott also crossed the red signal line. Since this time ABT has continued to generally increase in price.

As shown above, another bullish indicator is when the MACD Indicator crosses the Signal Line. This event may lead or lag the crossing of the centerline. Many investors focus on signal line crossings to time their entry or exit points. Many times the cross above the signal line indicates a change in trend.

Conagra Inc. (CAG) recently reversed a downtrend when the MACD indicator (blue) rose above the Signal Line (red). This occurred while the MACD indicator was still well below the centerline, providing investors an early signal to take a long position. The HingeFire screener discovered this setup when screen for the MACD indicator JCA the signal line earlier this week.

Bearish MACD Crossovers

One common bearish indicator is when MACD crosses below the centerline. This confirms that the trend has shifted from bullish to bearish. The previous history of MACD on a chart many times serves to underline the intensity of a cross below the centerline. A situation where the indicator dives from a high positive level down below the centerline indicates sharp downside price momentum. Scenarios where the MACD wobbles below the center line after several recent crosses usually indicates less conviction in bearish potential.

Tennant Co (TNC) had its MACD cross below the Center Line today. Despite entering bearish territory, the deficit of impetus in the indicator as it retraces below zero demonstrates a lack of conviction in the signal. While the HingeFire stock screener has picked up this cross below the Center Line, many traders would review the chart and search for other MACD cross below opportunities. This underlines the point that a screener is a tool that is focused on providing potential candidates, it is important for investors to do additional fundamental and chart research when selecting their stocks.

When the MACD Indicator crosses below the Signal Line it is usually a start of a bearish trend. The HingeFire screener found AK Steel Holding Corp (AKS) in a scan of MACD just crossed below (JCB) the signal line in late October. As the chart demonstrates AKS has continued to drop in price since this crossover. Many investors view that a MACD cross below is a good indicator of the start of a bearish trend, while an additional cross below the centerline serves as confirmation.

Combining MACD Signals

Many investors utilize MACD by combining signals. Some will screen for a bullish condition of the indicator above the signal line and just crossing the centerline. This looks for the confirmation of a bullish trend. Others may look for bullish conditions when the MACD indicator is already above the centerline and has just crossed above the signal line.

Inversely, bearish MACD signals can be combined in a similar manner. Investors may look for setups where the indicator is already below the signal line and just crossed below the centerline; or scan for conditions where MACD is below the center line and just crossed below the signal.

MACD Summary

Many investors also review charts for divergence between MACD and price. This situation usually indicates a significant disconnect in the market, implying that the equity is mis-priced based on market action. Some followers of the MACD indicator also review stock charts for the level of the MACD indicator, searching for key levels such at 0.5, 1, -0.5, and 1, as a pointer for future price action.

However the usual focus for MACD is on the Center Line and Signal Line. When the indicator crosses over these levels it usual serves as an important signal about a change in momentum for a stock. The HingeFire tool can be used to screen for the following significant events for the MACD indicator:

• Bullish Crossovers of the Centerline
• Bullish Crossovers of the Signal Line
• Bearish Crossovers of the Center Line
• Bearish Crossovers of the Signal Line
• Combinations of Bullish or Bearish MACD signals

Combining technical indicators such as Moving Average Convergence / Divergence indicator with commonly used fundamental criteria when selecting your investments helps put the market edge in your corner. The MACD support in the HingeFire Stock Screener adds a powerful tool for determining the momentum in the market so you can enter or exit your investments at the correct time.

Screening to Win: Fast and Slow Stochastic

This is the third installment in the series "Screening to Win". This article discusses utilizing the Stochastics technical indicator in your screening. The earlier commentary about Moving Averages and RSI can be found at:
Moving Averages
http://hingefire.blogspot.com/2007/11/screening-to-win-moving-averages.html
RSI
http://hingefire.blogspot.com/2007/11/screening-to-win-rsi-relative-strength.html

The overview below describes one of the common technical indicators – Stochastics and provides insights on how to utilize it in your stock selection. Hopefully this outline will provide traditional fundamental investors with some solid insight on how to incorporate technical indicators into their screening. The free HingeFire Stock Screener which can be found at http://www.hingefire.com is one of the few tools available that includes a wide selection of fundamental and technical criteria for selecting stocks. Using a combination of fundamental and technical screening is a powerful tool for winning in the market.

Slow and Fast Stochastic

Slow and Fast Stochastic Overview

The Stochastic indicator was originally developed by George C. Lane in the late 1950s and has gained wide-spread popularity since this time. The Stochastic indicator is a momentum oscillator that reveals the location of the current close relative to the high-low price range over a defined number of periods. Generally, levels that are near the top of the range indicate accumulation and those near the bottom of the range indicate distribution.

Stochastic oscillators normally utilize a 14 day formation period and a three day smoothing filter. The indicator is presented as a percentage running from 0 to 100. Stochastic indicators normally have two sub-components; %K line which is the unsmoothed relationship of the price to the highs and lows over a 14 day period, and %D line which applies a 3 days smoothing filter to this data.

There are two common stochastic oscillators; fast and slow. The fast stochastic oscillator adjusts more quickly then the slow stochastic. This is understandable because the slow stochastic indicator is normally created by applying an additional 3 day filter to the %D information associated with the faster indicator. As expected, the fast stochastic oscillator is more prone to whip-saws and quicker movement then its slower cousin.

The HingeFire stock screening tool provides support for both Slow and Fast Stochastic indicators. Support for the 20 (oversold) and 80 (overbought) levels is incorporated. Users can scan to determine if the stochastic reading is greater than or less than a particular level, and also establish if the fast or slow stochastic just crossed above (JCA) or below (JCB) these thresholds.

How to use Stochastics in screening

Most investors utilize stochastics to identify oversold and overbought conditions. Stochastic levels below 20 are generally considered oversold and above 80 are considered overbought. However a reading below 20 is not necessarily bullish, nor a reading above 80 bearish. Stochastic indicators can remain at these levels for lengthy periods of time. It is more important to focus on situations where the stochastic crosses below 80 indicating an exit from an overbought condition, or crosses above 20 indicating an egress from an oversold condition.

Both the %K and %D for stochastic indicators are normally displayed on charts. The recent chart of 3M Corp (MMM) shows an example of a slow stochastic that recently just crossed above (JCA) the 20 level. This is one of the stocks recently found using the HingeFire tool to screen for stocks whose slow stochastic just crossed above this level. Normally this is taken as a sign that the selling pressure is exhausted and the stock price is poised to rise.

As a point of interest notice the earlier price drops in the 3M chart that occurred when the slow stochastic level fell below 80. The drop below 80 indicates an exhaustion in buying and commonly leads to either a brief retrenchment or more significant drop in price

A fairly volatile stock Amerco (UHAL) recently had its fast stochastic just cross below (JCB) the 80 level. This cross below was followed by a price drop of more then $8 for the stock. Many traders utilize fast stochastic to get in on moves early.

Note the lag of the slow stochastic as compared to the fast stochastic for the volatile stock in the diagram above (both are plotted). A trader using the fast stochastic would have caught the recent move down near the peak; while an investor using the slow stochastic would have gotten in on this move much later. This is a solid demonstration of the difference between the two indicators; note that the slow stochastic is still a very reliable indicator for timing buys and sells for long term investors focused on non-volatile instruments.

It is generally deemed that investors should use a fast stochastic for the timing of medium term trades with volatile stocks. The slow stochastic is more useful to determine entries and exits for longer term investments, or if you find that the fast stochastic causes you to over-trade.

There is one school of thought that states that investors should look at charts and focus on the divergence between price and stochastic level near oversold and overbought levels. Many times the second time that the stochastic indicator crosses out of an overbought or oversold condition in a short period of time is deemed a better indication of final exhaustion in buying or selling.

In summary, many investors use the HingeFire tool to screen for the following situations with Stochastics.

• Break Above Oversold with Slow Stochastic – Screening for stocks that JCA the 20 level as entry points for long term investments on non-volatile stocks.
• Break Below Overbought with Slow Stochastic – Screening for stocks that JCB the 80 level as exit points for long term investments on non-volatile stocks, or possibly to short.
• Break Above Oversold with Fast Stochastic – Screening for stocks that JCA the 20 level as a long entry points for trades on more volatile stocks.
• Break Below Overbought with Fast Stochastic – Screening for stocks that JCB the 80 level as an entry point to get short.

Combining technical indicators such as Stochastics with commonly used fundamental criteria when selecting your investments helps put the market edge in your corner. The support for Slow and Fast Stochastic indicators in the HingeFire Stock Screener adds a powerful tool for timing your transactions.

Screening to Win: RSI (Relative Strength Index)

This is the second installment in the series "Screening to Win". This article discusses utilizing the Relative Strength Index technical indicator in your screening. The first article about Moving Averages can be found at:

http://hingefire.blogspot.com/2007/11/screening-to-win-moving-averages.html

The overview below describes one of the common technical indicators – Relative Strength Index and provides insights on how to utilize it in your stock selection. Hopefully this outline will provide traditional fundamental investors with some solid insight on how to incorporate technical indicators into their screening. The free HingeFire Stock Screener which can be found at http://www.hingefire.com is one of the few tools available that includes a wide selection of fundamental and technical criteria for selecting stocks. Using a combination of fundamental and technical screening is a powerful tool for winning in the market.

RSI

Relative Strength Index Overview

First if is important to not confuse the RSI (Relative Strength Index) technical indicator with the Relative Strength fundamental criteria. Relative Strength compares the price of a stock to an index (or another stock) over a period of time and performs a comparison; while the RSI momentum oscillator compares the magnitude of a stock's recent gains to the magnitude of its own recent losses and transforms that information into a number that ranges from 0 to 100.

Relative Strength Index was developed by J. Welles Wilder and introduced in his 1978 book, New Concepts in Technical Trading Systems. The basic components include the Average Gain, the Average Loss, and the calculated RS values over a period of 14 days. RSI converts the underlying information as an index that runs from 0 to 100. High values of RSI are generally considered an indication that the stock is overbought while low values are regarded as oversold.

The HingeFire tool provides support to incorporate RSI in your creation of screens for stocks. Support for multiple common levels is included. Users can scan to determine if a Relative Strength Index is greater than or less than a particular level, and also establish if the RSI just crossed above (JCA) or below (JCB) a threshold.

How to use RSI in screening

In his book, Wilder recommended using 70 and 30 and overbought and oversold levels respectively. His work postulated that if the RSI rose above 30 then it is considered bullish for the underlying stock. Conversely, an RSI dropping below70 is a bearish signal. Some traders identify the long-term trend and then use extreme RSI readings as entry points. For example if the long-term trend is bullish, then oversold RSI readings could denote possible entry points.

Since the time of the original RSI work from Wilder, many traders have adopted the 20 and 80 levels of RSI as the levels of most interest instead of 30 and 70. Which levels are of most value is regular subject of theoretical debate. The 20 and 80 RSI levels represent greater extremes that operate better in more volatile markets. Investors should try both and determine which are most useful for their stock selection process. The HingeFire tool provides support for all of these levels.

RSI is a momentum oscillator and a solid indicator of medium term trends. Investors normally use RSI to time transactions or to filter stocks to exclude.

Oversold Territory

Stocks with an RSI below 30 or 20 are considered to be oversold. Some oversold stocks are due for a bounce back. Others have negative fundamental and trend information associated with them and may continue to dive in price. A number of investors screen for stocks with low RSIs and then sort through the results to see if any gems are available at attractive prices.

Avnet Inc (AVT) recently endured a downtrend and has arrived at an RSI level below 30 which indicates that the stock has entered oversold territory. If an investor believes that the long term fundamentals associated with the stock are sound then they may select this as an entry purchase point and expect the stock to reverse the trend as the selling fizzles out.

Overbought Territory

Stocks with RSI levels above 70 or 80 are considered over bought. A number of these stocks may continue to rise and exhibit high RSI readings for a period of time. A good quantity of these stocks are due for a tumble however as they approach an exhaustion level of available purchasers in the market. A number of traders screen for high RSI levels and then review the charts for possible short candidates.

The RSI for Suntech Power Holdings (STP) recently crossed above 70 again. Note the previous price retrenchments of more then $8.00 when the RSI indicator rose above 70 in late October and early November as buying was exhausted.

Filtering Buys

A number of investors filter their potential purchase decisions with an RSI level of above 20. This will exclude stocks that are demonstrating continually lower days which have the possibility of dropping further over the upcoming weeks.

Filtering Sells

Investors focused on shorting stocks will filter the market for candidates with an RSI below 80. This avoids stocks exhibiting continually higher days that may continue to increase in price for a period of time (until exhaustion occurs).

Break above Oversold

One of the most common uses for RSI is to scan for stocks that just broke above the oversold condition and now should continue to rise. The HingeFire tool supports searching for stocks that just crossed above (JCA) various thresholds. A breakout above 20 or 30 indicates a solid change in momentum for a stock as it exits an oversold condition while increasing purchases occur.

Wyndham Worldwide (WYN) recently experienced a spree of selling with an associated drop in price over the past several weeks. The RSI just crossed above the 30 level which may be a signal that the downward momentum is broken and the stock price has potential to rise.

Break below Overbought

Inversely, another common use for RSI is to look for stocks that have just crossed below (JCB) the overbought condition at the 70 or 80 level. This normally serves as notice that the stock may continue to fall over the upcoming few weeks. Sometimes the stock will revert on increasing volume into the overbought condition again if new buyers flood the market; more normally this indicates the start of a medium term reduction in purchasers for the equity.

The RSI for Saul Centers (BFS) recently just crossed below (JCB) the 70 level. Note the several week downtrend that occurred with the stock after the RSI dropped below70 in mid- October. At this point the buying was confirmed to be exhausted and BFS continued to drop in price.

Avoiding Extremes

Some investors simply want to avoid extremes when timing their stock transactions. These investors will filter their decisions with an RSI >= 20 and < 80 (or use 30 and 70). This type of filter enables investors to avoid stocks that are currently in greatly oversold or overbought conditions. In many ways, this is a method of reducing volatility risk for long term investors.


RSI Summary

A number of investors look at RSI on charts to scrutinize for divergences between RSI and the price trend of the stock. There are also investors who utilize the mid-point of 50 as a single break level between rising and falling prices; however most screens based on midpoint show no real potential unless the investor evaluates the associated chart information. The most common utilization of RSI however is screening for oversold and overbought levels as outlined above.

Summing up, many astute investors use the HingeFire tool to screen for the following situations with Relative Strength Index.

Oversold Territory – Screening for stocks with RSI levels below 20 or 30.
Overbought Territory – Screening for stocks with RSI levels above 70 or 80.
Filtering Buys – Looking to purchase stocks only with RSI levels above 20.
Filtering Sells – Looking to only short stocks with RSI levels below 80.
Break Above Oversold – Screening for stocks that JCA the 20 or 30 level.
Break Below Overbought – Screening for stocks that JCB the 70 or 80 level.
Avoiding Extremes – Screening for stocks only between 20 and 80 (or 30 and 70).

Combining technical indicators such as Relative Strength Indicator with commonly used fundamental criteria when selecting your investments helps put the market edge in your corner. The RSI support in the HingeFire Stock Screener adds a powerful tool for timing your buy and sell transactions to pull excess alpha out of the market.

Screening to Win: Moving Averages

This is the start of a series of articles that describe how to successfully screen for stocks. The initial essays will cover some common technical indicators. The follow-up articles will provide examples of winning screens that utilize both fundamental and technical indicators. This material will eventually be placed on the HingeFire website.

At HingeFire, we believe that investors should take advantage of every aspect of screening to put the market edge in their corner. Fundamental criteria are an excellent gauge of the prospects for a company over a lengthy period of time. Technical indicators provide important clues about the short term momentum in the market, effectively reflecting the fear and greed of traders.

Investors with long time horizons can use technical indicators to enhance their returns. Studies have demonstrated that using technical indicators to time the entry and exits of long term investments can increase the basis return by over 4% points. It makes sense to use technical screening in conjunction with your fundamental examination of potential equity selections to boost your portfolio.

The good news is that technical indicators are not magical voodoo, most have sound theories behind their logic that all derives back to the innate psychology of the market. Additionally, technical values are simple to understand and helpful in implementing your market execution decisions so it behooves investors to comprehend them.

The overview below describes one of the common technical indicators - Moving Averages, and provides insights on how to utilize it in your stock selection. Hopefully this outline will provide traditional fundamental investors with some solid insight on how to incorporate technical indicators into their screening. The free HingeFire Stock Screener which can be found at http://www.hingefire.com/ is one of the few tools available that includes a wide selection of fundamental and technical criteria for selecting stocks. Using a combination of fundamental and technical screening is a powerful tool for winning in the market.

Moving Averages

Moving Averages Overview

There is an old expression that “Bulls live above the 200 Day Moving Average and Bears live below the 200 Day Moving Average”. In many ways this adage holds true. Associating a stock’s price level with its moving average is a very reliable approach to determine the trend.

The two most common types of Moving Averages are SMA (Simple Moving Average) and EMA (Exponential Moving Average). Simple Moving Averages are created by simply totaling the closing prices for the defined time period and dividing the total by the total number of days.

An EMA applies more weight to recent prices relative to older prices. The weighting applied to the most recent price depends on the specified period of the moving average. The shorter the period of an EMA, the greater the weight applied to the most recent price.

An exponential moving average will always tend to be closer to the current price then a simple moving average. From a reliability perspective, EMA has a tendency to “whip-saw” more then SMA moving averages, providing short-term false breakout and directional change signals, due to its reliance on more recent information. Conversely EMA provides a quicker indication of the underlying changes in the pricing of the equity, allowing an investor to jump on board changes in trend. The question of which moving average is best is subject of a “religious debate” among theoreticians. Investors should try both and determine which is most useful for their selection process.

The HingeFire tool provides support to incorporate moving averages in your creation of screens for stocks. Support for both SMA and EMA is included. Users can scan to determine if a stock price is greater than or less than a particular moving average, and also determine if the price just crossed above (JCA) or below (JCB) the moving average today. The tool also provides the capability to compare the levels of different moving averages.


How to use Moving Averages in screening

The HingeFire screener supports allowing users to determine if today’s closing price is above or below the SMA or EMA for multiple time frames. Most investors view that closing prices above or below the moving average in longer time frames such as 200 day, 100 day, or 50 day provide a solid indication of a stock being bullish or bearish. Many investors use this assessment as a filter for their entries, typically going long on stocks whose prices are above their long term moving averages and tending to short stocks below these levels.

Short-term moving averages provide information on quick price acceleration or deceleration. A stock that is above its 5 day and 20 day moving average is likely to be accelerating in an uptrend and is prone to continue an upside breakout. A cross-over back below a short-term moving average can serve as a signal that a stock upswing is exhausted and it may be time to take profits.


AeroCentury Corp (ACY) recently broke out above its 20 day and 5 day SMA. Many momentum investors look for these conditions as entry points, and would view the stock price dropping back down below these levels as a sign of exhaustion and exit the trade. ACY was simply one of many stocks found when using the HingeFire tool to screen for the closing price being above the 20 day and 5 day SMA levels.

The HingeFire tool also supports determining if the pricing has just crossed above (JCA) or just cross below (JCB) a moving average level. These cross-overs potential indicate a change in trend from bearish to bullish or visa-versa. Many investors screen for these cross-over changes in order to scope out stocks that have potential before they become widely exploited by the market.


For example the stock price of Techwell (TWLL) just recently broke out above its 200 Day SMA near $12.65; this many times serves as notice of a change in momentum for the stock. Many investors would view this as a possible entry point if they believed that the stock had sound fundamentals.

The comparative level of moving averages to each other also reveals noteworthy information about stocks. The HingeFire screener supports comparisons such as the 200 and 50 day moving average levels. Support for JCA and JCB is also provided for comparing these moving averages. Many investors view that when a 50 day moving average crosses over the 200 day moving average, it serves as confirmation of the bullish signal for the stock. This type of confirmation usually lags the exact start of the trend but helps investors avoid situations where the trend quickly reverses.


Recently the 50 Day SMA of Avon Products (AVP) crossed above the 200 Day SMA; many investors would view this as solid confirmation of the bullish trend. Avon is one of the stocks that came up this past week in a scan of the 50 day SMA (red line) crossing above the 200 day SMA (blue line) using the HingeFire stock screener.

Moving averages can also serve as a support level, occasionally news will come out about a stock that causes the price to drop near its 200 day or 50 day support level. Sometimes the stock price will bounce-off of these support levels rather then diving below them with significant volume. Numerous investors screen for these situations as entry points and purchase their stocks near these support levels.


A recent example is CSCO dropping to its 200 day support level shortly after its recent earnings report. A regular screening of Cisco would show the price dropped slightly below the 200 day moving average (blue line) near the 9th of November. Many investors with a bullish fundamental long-term outlook on the stock would view this as an entry point to purchase CSCO.

Note that long term moving averages can also serve as resistance levels with some stocks having difficulty penetrating this barrier with volume sufficient to carry them higher. Investors focused on shorting commonly screen for scenarios where prices fail to breakout solidly above larger time frame moving averages.

In summary, many knowledgeable investors use the HingeFire tool to screen for the following situations with moving averages:

• Equity prices being above or below long term moving averages function as a filter to either purchase the stock long or sell the stock short.
• Prices rising above or dropping below short term moving averages act as a momentum breakout indicator or serve as a profit taking point.
• Prices crossing over larger time frame moving average levels indicate a change in long term momentum. This serves as a possible entry point for investors to beat the crowd.
• Comparison of moving average levels act as a confirmation of a trend.
• Moving average levels serving as support or resistance levels.

Combining technical indicators such as moving averages with commonly used fundamental criteria when selecting your investments helps put the market edge in your corner. The HingeFire Stock Screener provides support for both fundamental and technical indicators, a powerful combination that will enable your success in the market.