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Tuesday, May 27, 2008

Using the new TradeRadar software - a more complete strategy

With the latest release of the TradeRadar software (we're up to version 3.0.1 now), I thought I should provide a description of the trading system the software supports.

History --

The earlier releases of the software focused on technical analysis of closing price data.

We started out with the basic BUY/SELL signal logic including measures of how strong the signal is, how well-shaped the signal is, etc.

The next version added trend lines whose angles were measured and used to determine whether the signal was strong enough.

With these indicators, we added what look like colored LEDs on the Dashboard screen of the software where the detail of the indicator computations is presented. The LEDs would be set to Red/Yellow/Green based on whether the individual indicator was strong enough to support the BUY or SELL signal. For example, if you are looking for a BUY signal and the LED is Red, then the indicator is saying that a BUY signal is not confirmed. If all or most of the LEDs are Green, then the BUY signal is confirmed.

Since the TradeRadar software attempts to identify changes in trend, version 2.0 brought a set of technical indicators that are commonly used to identify or confirm trends. We added Aroon analysis, DMI and Chaikin Money Flow. We also provided an indicator that showed where the stock was in terms of its 50-day exponential moving average. All these indicators also had LEDs to quickly show the outcome of the computation and whether they confirmed the BUY or SELL signal.

The latest TradeRadar system --

With version 3.0 we added fundamental indicators to the program. This is a departure from the previously purely technical approach; however, it makes sense.

Let's look at what's going on when we use TradeRadar to identify a BUY signal. We look for a stock that has been in a prolonged down trend over the course of six months to a year and then we try to identify whether a trend reversal is taking place. What does this imply?

We are trying to catch a stock soon after it bottoms and begins to turn up. In other words, we are looking for a stock when it is relatively cheap. What does this sound like? It sounds a lot like value investing.

Momentum investors are well-known chart users. Value investors focus on the fundamentals. We have now added a number of fundamental indicators specifically chosen to help determine whether the stock is over-priced, fairly priced or a good value.

The new indicators are as follows:
  • Price to Sales Ratio - the lower the number, the better value a stock is
  • Price Earnings Ratio - the lower the number, the better value a stock is
  • Market Capitalization - this number is intended to help identify whether a stock is a micro-cap and is also used in the Cash Flow Yield calculation
  • Price Earnings Growth (commonly known as PEG) - the lower the number, the better value a stock is
  • Cash Flow Yield - the higher the number, the more cash per share is being generated by the business that is available to shareholders. Data from most recent quarter is used and then annualized.
As with all the other indicators, we have the Red/Yellow/Green LEDs to show when the individual indicator is in a good range. As a user, you do not have to become an expert in financial ratios any more than you need to become an expert in technical indicators. The program does the work for you.

Note that for more detail you can look up all these fundamental indicators at various web sites such as Investopedia.

Using the fundamental indicators --

Taken together these indicators provide a good picture of whether the company is profitable, whether its price fully reflects its growth rate and whether it is generating enough cash to run the business. Whether a company is profitable or not, price-to-sales is a good way to determine whether the stock is over-valued.

There are many stocks that do generate good technical BUY signals. As an investor, however, wouldn't you rather choose the company that is in the best financial shape?

Hopefully, the new TradeRadar software will help you separate the weak stocks from those about to become resurgent. The combination of technical and fundamental indicators should help minimize downside risk and provide a good analysis framework for your investing decisions.

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