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A Trader's Mentality

Follow us on Twitter @Schwab4Traders. This blog updates the first Tuesday of the month; next installment publishes October 2nd.

The top-down trading method can help traders remove some of the more common biases we face, like buying weakness or anchoring to prior prices. 

My approach to trading the market begins with the knowledge that I trade with the trend.  I prefer to buy stocks which are already in an uptrend to increase the likelihood of success.  Eventually, every trend will come to an end and this approach will result in a loss.  However, I’m a trader.  I know that not all of my trades will be profitable.  I work to minimize loss and allow my profits to continue to run.   

I’m sure you’ve attempted a bottom-up trade in the past.  You saw a ticker symbol on the crawl of CNBC or Bloomberg.  Maybe your neighbor mentioned a stock they’ve been making money in recently.  You decide to dig in and research the stock to see what it is all about.  But, this is where we encounter biases.  By starting from the symbol you may subconsciously feel this is a stock you should own.  The human mind encourages you to find reasons to buy it.  When starting from the symbol, you might find it difficult to step away from this stock, regardless of what your research finds.

The top-down method to locating stocks will challenge this bias. By starting broadly, looking into groups already trending upward will help to ignore the weaker candidates in a group and lean on the strong ones. 

Start with the return details of the Sectors and Indices of the U.S. Market.  List the 11 sectors, along with Dow Industrial Average ($DJI), the NASDAQ ($COMPX), S & P 500 ($SPX) and perhaps the Russell 2000 ($RUT).  Include a column for ‘% from 52 Week High’ and sort by it.  Now you see the top producing groups for the prior 52 weeks.  We see the $RUT is the leader among the indices and XLY (Consumer Discretionary) the leader among the sectors.  We can take this knowledge and screen within both these groups.

Source: StreetSmart Edge®

  1.  Specify Consumer Discretionary Sector here
  2. Indicate stocks must be within S & P Small Cap 600 here

 

Source: StreetSmart Edge®

Screening for stocks using the top-down method like this does not guarantee your success.  A trader still needs to incorporate risk management techniques to help build the appropriate trade.  In our next discussion, I’ll address a proper risk management strategy and how to incorporate this into your research.

What You Can Do Next

  • Register for an upcoming no-cost webinar to dive further into trading topics that interest you.
  • Open a Schwab Trading Services account to access our best tools and services for traders.
  • Read more timely content from our other Schwab trading specialists 

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Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Schwab does not recommend the use of technical analysis as a sole means of investment research.

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