Unlock Stock Market Profits - Key #1

This is the first in an ongoing series of articles where I discuss what I feel are keys to successful investing. It is based on a post that provides a summary of the ten keys that individual investors should use to identify profitable stock trades. (Click here to read the original post)

There are two basic steps to investing. First, you need to find stocks that seem to have some potential. Then you have to determine whether these stocks are actually good investments. There are many stocks that at first glance look interesting, but further research reveals that there are too many negatives to warrant taking a position.

This first post in the series starts at the beginning: getting good investment ideas.

Key #1: If something special is happening to a stock, it will be reflected in some kind of unusual activity in the markets.

As individual investors, we will never be the first to know; however, unusual activity can be an early sign that allows us to follow the Wall Street professionals and other insiders when a stock is just beginning to make a move. If the stock represents a quality company and your research reveals that the stock has the potential for longer term appreciation, you will not be too late to invest and profit.

The lists we will see will have lots of stocks on them. We need some kind of criteria so we can weed through the list. My own typical criteria is for a stock to be coming out of a down-trend and starting to show some upside momentum. In other words, experiencing a reversal. Also, I tend to like stocks that are not too small (ie, no stocks under $1) and whose business I understand at least somewhat.

There are numerous measures of unusual activity and there are web sites that present lists of stocks based on the different measures. Let's take a look at a few.

Volume

First up is the Wall Street Journal Online. If you click on US Stocks and select the Most Actives: NYSE, Nasdaq, Amex link you will get a simple list of stocks that were on the most active list (greatest number of shares traded) for one trading day. I like this list because you can roll over the name of a stock and a box pops up that shows a chart and a few other useful pieces of information. This provides a very quick way to perform a high-level analysis and determine if you would like to investigate this stock further. Going down the list for July 20, 2007 I come across Starbucks (SBUX). This is a good-sized company and I understand their business. What about the chart? The pop-up displays the daily chart so I click on the "1 year" link and take a quick look at the one year chart. It has been in a down-trend, alright, but it appears that it might be undergoing a reversal. Clicking on the "10 days" link shows me that the stock price just recently popped up. This looks good and I'll file it away for further research.

Another good measure of unusual activity is Volume Percentage Gainers. For this exercise, we will limit ourselves to those stocks that showed a gain in price for the day. Staying on the Wall Street Journal site and looking through the list for the day of July 20, 2007 we find one company that looks like it might fit the bill, IDT Corp. (IDT). The stock was up 2% on daily volume that was 300% higher than usual. Something good must be going on here!

Gaps

Gaps represent another kind of unusual activity. Over at the Schaeffer's Research Stock Screen Center, we can look at a list of stocks whose price jumped up. For the day of July 20, 2007 we find a lot of stocks that are already in a good, solid up-trend. The only one that shows a nice gap up from a down-trend is Partners Trust Financial Group Inc. (PRTR). Unfortunately, they gapped up because they are being acquired so they don't make our list.

Volume and Price Combined

Another good unusual activity screen at Schaeffer's is Yesterday's High Volume Gainers. These are stocks that have gained 3% or more in the previous day's trading on at least double the average trading volume of the past quarter. Here we find two potential candidates: Medicines Co. (MDCO) reversing from a down-trend and PRG Schultz Intl. (PRGX) that is breaking out of a trading range and moving to the upside.

Options Activity

Let's try one more at Schaeffer's site, Unusual Daily Option Activity. Explosions in volume may be the result of corporate news or an impending earnings announcement. They can also be spurred by "smart money" who may have an inkling that market-moving news may be on the horizon for the underlying security. Looking at unusual call activity, we find our friend Starbucks listed. So now we know that both stock and options activity have been unusually high for SBUX. This company definitely merits a deeper look.

In Conclusion

I have demonstrated how we can find investing ideas using unusual activity as a criteria. In the examples presented, we looked for stocks that had been in a down-trend and might be undergoing a reversal to the up-side. The technique could also be used to identify stocks that are already in an up-trend. Using this approach we can filter the universe of stocks and find those with potential.

Be sure to check back for the next post in this series where I will discuss stock screeners.