How You Can find the next big stock market winner

By: Alex Chambers

That would be nice wouldn't it - to find the next big winner in the stock market. Just take a look at these beauties on the US market (from 2004):

  • TZOO
  • NTRI
  • HANS
  • TIE

What do they all have in common?

Firstly, they were all momentum stocks. And secondly, they all made massive gains in a short space of time. These are:

  • TZOO: 100% return in 6 weeks, 2004
  • NTRI: 400% return, May 2005 - Jan 2006
  • HANS: 1000% return, June 2004 - May 2006 (split adjusted)
  • TIE: 400% return, July 2005 - May 2006 (split adjusted)

Before we continue, let me introduce myself. My name is Alex Chambers. I'm a UK medical doctor who has an interest in the stock market.

So how do you find these stocks in a sea of many?

Of course, there's no magical answer. Don't believe anyone who claims there is (especially if they are selling you an expensive trading system or offering a "hot tip"). However, there are some tell tale signs that these type of momentum stocks give off to alert you to their presence, and I use these to scan the market:

1) They are forming new all-time highs

2) They lie dormant for a while, then suddenly "wake up" - ie. they break out of a prior trading range. This can be anything from a year or two to many.

3) They then experience rapid price rises with a marked increase in volume (the concurrent increase in volume with price is very important - it donates the stock is being accumulated)

4) They are leaders of a new general market uptrend

5) They are generally priced greater than $10

This is in essence the system that Nicolas Darvas invented and used in the 1950s to make his $2million fortune - trading on week old data.

Darvas detailed his exploits and how he created his system in his classic 1963 text, "How I Made $2,000,000 in the Stock Market". It’s a great read and I highly recommended it. Many investors regard the text as a classic. In it he provides an honest and open look at his experience from his naive start to his eventual success. He lays out, in great detail, exactly what he did and how foolish some of his actions were. Then he explains how he came to find success by focusing on the price and volume action of stocks.

A key message of his strategy is as quoted as follows:

"...My only sound reason for buying a stock is that it is rising in price. If that is happening, no other reason is required. If that is not happening, no other reason is worth considering..."

I have created several pages in my website to describe exactly how Darvas did this, and how to apply it to the modern stock market - especially the stocks above that made such large gains.

In addition to the criteria above, I like to look for stocks which have a low float (usually under 30 million) and have have good insider ownership. These last two rules, however, are not set in stone. If faced with two stocks that look good, I would go for the stock with the lower float and higher insider ownership. When the price takes off in these small float stocks, it can really go off!

However, selecting stocks is only one part of a trading system. Just as important are:

- Money Management and position sizing

- An entry and an exit strategy

Without these you are relying on your emotions. And believe me, trading emotionally is a recipe for disaster. You need a SOUND plan so you can sleep at night and not worry about your stock.

Money management is of particular importance: you may wonder what this has to do with finding the "next big thing" in the stock market, but no single trading plan will ever be 100% successful hitting winners. In fact, most good traders hit a 40-50% run of winners at most - especially in the momentum stock market. But if you limit your losses in the 60% that don't make profits and use a sound money management plan, then you only need 2 to 4 out of 10 trades to be successful to make a nice gain.

I use a variant of Darvas' Trading System which is aimed at weekly trading (it can, however, be applied to any timescale). It has clear instructions on how to trail a stop loss to protect the profits as they appear. This is of particular importance with momentum stocks, when prices can go down just as quickly as they go up. Trailing stops have the added bonus of removing the worry of when to sell - is it the right time or not? You simply "cut your losses and let your profits run".

If you're interested in more details and how I use apply this to real stocks, please check out my website. All information is free.

To your stock market success also,

Alex Chambers

Trading
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