I use charts and technical indicators to make buy and sell decisions, especially in Stocks on the Run where I and Yiannis Mostrous re looking for shorter term “trades” rather than longer-term investments.

— Elliott Gue, Stocks on the Run

2010 is no more, but it was definitely a good year. The Dow ended up 11%, the S&P 500 rose 13%, and the tech-heavy Nasdaq was king of the hill with a 17% gain. Anyone who followed the Hindenburg Omen and/or cardinal climax sell signals in August got his head handed to him, proving that technical and astrological indicators aren’t infallible.  Furthermore, anyone who sold stocks because of the mid-term congressional elections also made a mistake. The lesson to be learned: when the Federal Reserve has short-term rates at zero and is turning on the money spigot full blast with multiple rounds of quantitative easing, no normally reliable bearish technical indicator is going to work.

Best Stocks of 2010

Let’s look at which stocks performed best last year. Perhaps by looking at the winners of the past we can learn something about the winners of the future. On the other hand, the extraordinary bullish monetary environment the U.S. markets experienced in 2010 is unlikely to be repeated, so the type of stocks that benefitted from that special market condition might not repeat in 2011.

Whatever, I used my trusty Bloomberg terminal to screen for the best-performing stocks last year that had market caps above $200 million at the beginning of 2010 and have average daily share volume above 200,000. Sure, some microcap stocks had even larger gains, but they are usually thinly traded and incredibly risky, so I view them as non-investable. Let’s deal with reality and the types of stocks that reasonable people would actually consider buying. The top-ten list is below:

Stock	Return in 2010	Industry
Acme Packet (NasdaqGS: APKT)	383%	Internet communications equipment
TransGlobe Energy (NasdaqGS:TGA)	380%	Canadian oil & natural gas exploration
Entropic Communications (NasdaqGM: ENTR)	293%	Semiconductors
MIPS Technologies (NasdaqGS: MIPS)	242%	Semiconductor memory chips
Polypore International (NYSE: PPO)	242%	Separation and filtration equipment
Travelzoo (NasdaqGS: TZOO)	237%	Internet travel
Spreadtrum Communications (NasdaqGM: SPRD)	236%	Chinese semiconductors
Finisar (NasdaqGS: FNSR)	233%	Computer network equipment
Ladish (NasdaqGS: LDSH)	223%	Metal fabrication
Netflix (NasdaqGS: NFLX)	216%	Internet-based movie rental

Source: Bloomberg

Most are Internet and semiconductor companies. Those industries may be good sources of stock ideas again in 2011. 

Technical Analysis Helps Find Future Stock Winners

But good traders don’t “guess” what stocks are going to do well. Predictions are for egotists and losers. Rather, as I wrote in So, You Want to be a Trader?, original “Turtle” Curtis Faith says winners are those with humility who follow the trend:

Humility allows you to accept the future as something that is unknowable. Humility will keep you from trying to make predictions. Good traders don’t try to predict what the market will do; instead they look at the indications of what the market is doing.

Let the market tell you which stocks are doing well and jump on those. Elliott Gue, co-editor of Stocks on the Run, the short-term trading service aiming for double-digit returns in three to nine months, is one of those rare, humble traders that doesn’t guess. In an advisor roundtable on market timing, he explained that his methodology for making trades includes both technical analysis and fundamental research. Elliott stressed that technical analysis is just a first step used to screen out stocks in an obvious downtrend. He only invests in companies that pass both his technical screen and have strong fundamentals:

Every evening after the close I run a series of screens, looking for companies making big moves or moving on unusually heavy volume. I scan well over 100 charts every trading day, simply looking for sectors and stocks that are seeing increased attention or that appear to be trending.

I then take a more detailed fundamental look at these firms; on many occasions these screens highlight trends I would have otherwise missed. When trading stocks, I look at charts to determine when to buy a stock and where to set stop losses.

Neither Elliott nor his co-editor Yiannis Mostrous has shared with me how they determine which stocks exhibit “increased attention” or “trending” behavior. Their “secret sauce” technical indicators for picking short-term winners are proprietary. But I definitely am a devotee of using technical analysis as one of my investing tools. Unlike Elliott and Yiannis’ sophisticated proprietary indicators, I just use two “off the shelf” technical indicators to help me in my stock picking: (1) moving average convergence-divergence (MACD) and (2) stochastic oscillator.

MACD

The MACD has two components: (1) a “long”-period moving average of stock price; and (2) a “short”-period moving average of stock price. The default setting used by most charting packages is a 26 period and a 12 period. These periods can be days, weeks, or months. My personal preference is to use weeks as my period because I want to jump on trends that last many weeks rather than just a few days. The downside of this approach is that you get fewer trading opportunities than if you use days as your period, but that’s ok with me since I am busy with a day job and can’t trade constantly anyway.

MACD is defined as:

MACD = Short-period moving average minus long-period moving average

A positive MACD means that the short-period is higher than the long-period. This suggests an increase in positive momentum. Similarly, a negative MACD suggest negative momentum.  A short-period moving average reflects more recent price action and is thus more indicative of the future than the long-period moving average. This begs the question why you need the long-period moving average at all. The reason is that the long-period moving average provides a baseline. A rising short-term moving average doesn’t mean much in isolation; it could actually signify a deceleration of price increase if it is less than a longer-period moving average. By using both, you ensure that price momentum is increasing.

As a further check, MACD has a third component called a signal line. This is a moving average of the MACD, typically a nine-period moving average. Moving averages of moving averages may sound like overkill, but the signal line acts as a smoothing agent that filters out short-term head fakes that don’t actually signify a trend. When the “fast” MACD crosses above the “slow” signal line, it’s a good sign and vice versa. 

But keep in mind that the MACD can cross above the signal line even when the MACD is below zero (i.e., negative). Consequently, some traders only act on signal line crossovers when MACD is above zero. I don’t like above-zero crossovers because they often occur when the stock’s upward momentum is peaking and likely to reverse. Personally, I like to act on signal line crossovers below — or at — zero but require additional confirmation that the stock is in a long-term uptrend. Specifically, I need to see both a stock’s 50-day (10 week) moving average and 200-day (40 week) moving average in an uptrend.

With both longer-term moving averages in an uptrend, a signal line crossover below zero signifies to me that the price correction is stalling and suggests a resumption of the uptrend. I like to get in near the beginning of an uptrend rather than near the end, but my bottom-fishing technique also risks jumping onboard during a continued downtrend. Choosing to act on signal crossovers above or below the MACD zero line depends on which poison you pick, either risking momentum that has peaked (above zero) or a downtrend that will continue (below zero).

Stochastic Oscillator

Whereas the MACD has no lower or upper boundaries, the stochastic oscillator, with a fixed range of zero to 100, does. Consequently, I like to use the stochastic oscillator in conjunction with MACD because it provides me with indications of overbought and oversold. For example I would be much more likely to jump on an MACD signal crossover above zero if the stochastic oscillator is nearer to zero (oversold) than 100 (overbought). 

The stochastic oscillator simply tells you how close the stock price currently is in relation to the highest price and lowest price it has traded at over a certain time range:

Most charting packages use a 14-period timeframe for calculating the stochastic oscillator. As with the MACD, I like to use weeks as my period of choice. If the stock is trading at the highest price of the range, the stochastic oscillator is 100 and if the stock is trading at the lowest price of the range, the stochastic oscillator is zero.

MACD is my primary technical indicator and stochastic oscillator is my secondary, confirming indicator.  Since I like to act on MACD signal crossovers below or at zero, I like to see the stochastic oscillator above 20 as further confirmation that a correction is ending and an uptrend resuming.

Keep in mind that the stochastic oscillator only works as an overbought and oversold indicator in choppy, range-bound markets. In strongly trending markets, a stochastic oscillator reading above 95 simply means the uptrend is strong; it doesn’t signify a stock is at a resistance point and an imminent reversal is about to occur. In fact, if the stochastic oscillator remains above 95 for more than three consecutive periods, it is considered “embedded” and suggests a strong uptrend is in progress. As with most things, context is everything. 

MACD and Stochastic Oscillator Stock Screen

Using my Bloomberg terminal, I performed a technical screen to find stocks that meet the following criteria:

• Weekly MACD signal crossover at or below zero
• 10-week and 40-week moving averages in uptrends
• Weekly stochastic oscillator above 20 and rising from below 20

I got seven results. These stocks exhibit bullish tendencies and may be primed for many more weeks of upside price action:

MACD and Stochastic Oscillator Stock Screen

Stock	Market Cap	Industry
Gerdau (NYSE: GGB)	$20.4 billion	Brazilian steel
Posco (NYSE: PKX)	$33.5 billion	South Korean steel
Republic Services (NYSE: RSG)	$11.6 billion	Trash collection
Parexel International (NasdaqGS: PRXL)	$1.2 billion	Biopharmaceutical research services
Advanced Energy Industries (NasdaqGS: AEIS)	$609 million	Industrial power conversion electronics
Southwest Bancorp (NasdaqGS: OKSB)	$250 million	Bank
AZZ (NYSE: AZZ)	$511 million	Industrial electrical equipment

Source: Bloomberg

Keep in mind that this is only a stock screen based on very basic technical price action; it is not a list of buy recommendations. Further due diligence is required to see whether any of these companies have solid economic fundamentals that justify further upward price action.

Jump on Momentum Stock Winners with Stocks on the Run!

Like I said earlier, Elliott and Yiannis use proprietary technical indicators to help them pick big stock winners over a three-to-nine month timeframe in Stocks on the Run. They are much more sophisticated than the “off the shelf” MACD and stochastic oscillator technical indicators I wrote about today.

If you are looking for a short-term trading service that can spice up your investment returns with some quick individual stock winners in three to nine months’ time, Stocks on the Run is just what the doctor ordered.

Right now, Elliott and Yiannis are recommending an emerging market metals and mining powerhouse, a high-tech electronics play, and four other stocks primed to deliver double-digit gains quickly. To find out the names, give Stocks on the Run a try today!