Advanced Stock Market Trading - Level 2_5. Manage “watch lists”

Lesson 5: Manage “watch lists

U.S. stock exchanges list more than 8,000 issues, but the typical trader or fund
manager accesses just a fraction of this bounty because they’ve failed to build
effective watchlists. This happens because identifying stocks that fully support
working strategies requires a number of skill sets lacking in most participants.
Despite the learning curve, the effort is worthwhile because it marks a trading edge
that lasts a lifetime.

A well-organized watchlist requires an understanding of our modern market
environment, how different levels of capitalization impact price development and how
different sectors react to catalysts over time. Seasonality, sentiment and economic
cycles all come into play when picking out candidates you want to follow on a daily,
weekly or monthly basis. It’s a complicated process that requires daily maintenance,
but the long and short-term rewards are well worth the effort.

Watchlist requirements align with the amount of time the participant has to trade and
to follow the financial markets. A part-timer playing a few positions each week can
keep things simple, culling a list of 50 to 100 issues to track on a daily basis.
Committed at-home traders and all levels of market professionals need to spend
more time on the task, building a primary database that contains between 300 and
500 stocks and a secondary list that fits on their trading screens.

As a general rule, each trading screen can accommodate 25 to 75 issues depending
on space taken up by charts, scanners, news tickers and market depth windows. It’s
a good idea to devote at least one screen entirely to tickers, with each entry
displaying just two or three fields, including last price, net change and percentage
change. Add a single chart to this page if you’re visually oriented, linking the tickers
to allow a quick review of price patterns during the trading day.

Stocks getting daily attention on your trading screens can come from multiple
sources, but a carefully maintained database will provide the majority of these issues
while allowing continuous replenishment whenever a specific security gets dropped
due to technical violations, dull action or a shift in market tone. Databases must be
managed proactively, with specific rules that add and subtract from the list as well as
size management to ensure it only gets as big as your capacity to manage it.

Start the database by adding a handful of market leaders, or laggards if you’re
focusing on the short side, from each major sector and capitalization level down to
$250 million. These sector lists are widely available on the Internet and in most
charting software packages. Avoid thinly traded issues during this step, because
most carry wide bid-ask spreads that aren’t conductive to an active trading style.
Next, create a list of your favorite stocks. Add this list to the database as a
permanent group that you’ll watch through all types of uptrends and downtrends.

Don’t skip sectors you’re not trading at the time, because you want to be up and
running if rotational behavior hits the market and they suddenly become the darlings
of Wall Street. So take the time to peruse all groups, including real estates
investment trusts, utilities and high yielding instruments that traders tend to avoid
when looking at opportunities. Foreign stocks trading as American Depository
Receipts can also be added as long as you stick with highly liquid issues and charts
that aren’t riddled with holes due to nightly gaps.

Now it’s time to scan the market, looking for stocks that meet specific criteria that
match your trading style. Once these issues are added to the database, you’ll have a
working list that can be rescanned nightly for specific patterns and setups, as well as
used to cull out issues you no longer wish to follow. Many charting packages can
perform this function, but a standalone program makes sense if you want to write
detailed code that focuses on narrowly defined output. This core program should
also have the functionality to scan for new issues, as well as to rescan an existing
list.

Avoid being too specific in the initial scanning criteria because your visual review
after candidates are added will be more valuable in finding specific opportunities.
The objective is to identify candidates you can follow on a daily or weekly basis,
watching your favorite patterns and setups come into play. Use the nightly scan after
database creation to focus on more narrowly defined criteria, like stocks sitting at key
resistance levels that could break out in the following sessions.

Combine simple technical and fundamental criteria to add stocks that may draw wide
attention in coming weeks. For example, a scan that includes "price vs the 50-day
EMA" and "earnings growth over X quarters" combine nicely to uncover the same
stocks that Wall Street analysts are watching from their desks in lower Manhattan.

It’s a waste of time to spend hours creating flawless scanning code that finds perfect
gems and no losers, because your eyes will do a better job filling in the missing
pieces as long as you commit yourself to reviewing the list nightly or weekly. The
objective is to build a loose but effective list, adding and subtracting as you move
forward but keeping most of the entries for months at a time, rather than rebuilding
from scratch each week.

Common Ways to Scan the Market include Candlestick hammers and dojis that
identify one-bar reversals. Then there are Securities with high or low relative strength
undergoing counter trend pullbacks. More common practices include following
Patterns that may signal trend changes, higher or low, setting alarms that measure
unusual activity, like 3 to 5 times average daily volume with little or no price change,
following percentage change today, in the last 5 days, or in the last 30 days, filtered
by greater than average daily volume.
Many follow Popular breakout and breakdown signals and Weak rallies into
resistance in downtrends.

In the final analysis, build an effective watchlist in three steps. First, collect a handful
of leadership or liquidity components in each major sector. Second, add scanned
listings of stocks that meet general technical criteria matching your market
approach.Third, rescan the list nightly to locate patterns or setups that may produce
opportunities in the following session while culling out issues you no longer want to
follow, due to technical violations, mergers, secondary offerings or other activities
that make it less likely you’ll take exposure.