Stock selection is one of the most important aspects of trading. Selecting the right stocks to trade can dramatically affect your bottom line. With over 5,000 actively traded stocks out there, picking the right ones to trade is no easy feat. So where should you begin?  That answer depends, of course, on your trading style, objectives, and risk tolerance. 

For swing traders, who look to hold positions anywhere from one to several days, they need the stock to move and move immediately. They can’t wait weeks or months for the stock to move. Swing traders seek to climb aboard and ride out the trend for a few points here and there. It is not about picking tops and bottoms. So in order to identify the best stocks to swing trade, I will outline a simple yet effective method to help you to select the best movers. Most of the resources you’ll need to utilize this method are right here at TradingMarkets. One of the main premises of technical analysis states that everything is discounted in the price. With this said, this method is based solely on technical analysis. 

The trading game is not easy, to improve your probability of success, you need to stack the odds in your favor. First off, the majority of your trades should be in the direction of the general market averages (S&P 500, NYSE Composite, and Nasdaq). As the old saying goes, “a rising tide lifts all ships.” Second, even in times of tough market conditions, money can’t hide. Money is constantly shifting around looking for a home. We have to identify where the money is going to and where it is coming from. Lastly, once we’ve determined the overall market environment and the best- and worst-performing areas, it’s time to focus on finding the best individual stocks to trade. Like stars in the sky, some just shine brighter. So buy shining stars and sell the burned-out falling ones.

Overall Market Analysis

First, look at a chart of the S&P 500 or Nasdaq Composite. Look at the one-year daily chart and examine:

• Trend – The trend really is your friend. Determine the general trend of the market. Is it up, down, or sideways? 
• Trendlines –  Draw trendlines at important highs and lows and see if any of the trendlines are violated.
• If the indices are under the 200-day moving average, trade from the short side. If they are above it, focus on the long side.
• Look at our Market Bias Indicators. Examine the CVR signals, if two or more CVR signals show a directional bias the opposite of your determined market direction, stand back, as there could be a short-term move in the opposite direction.

The charts above show that both markets are in a steep downtrend. They are also well under their 200-day exponential moving averages, which shows that we’re in bear country. Therefore the majority of our trades should be on the short side.

We had no CVR signals at the close of April 6. This means that we have no short-term directional biases to either side. 

Sector Analysis

Now that we have determined the general market direction, we want to find out what areas of the market money is going to or leaving. Stocks often move in groups, and an easy way to find the best and worst groups is by going to our stock indicators page and looking at the strongest and weakest sectors for the past five days. Being in the right sector or group is very important. Again, look at the daily chart and examine:

• Patterns – Breakouts, double tops and bottoms, triangles, head-and-shoulders, etc.
• Momentum – Make sure that momentum is moving in tandem with price. If any divergences exist, look for another sector.

From the previous illustration, we see that just about all of the selling is concentrated in the technology area. So that’s where we want to do our selling.

The above chart of the Pacific Stock Exchange Technology index shows a steep downtrend. The 10-day momentum indicator also started to head back down. 

Despite the weakness in the techs, other sectors such as oil services, drugs, chemicals, retail, and health care are still doing well.

The oil services sector was strong as the index broke above resistance. The momentum indicator rose as well.

Individual Stock Selection

At this stage, we’ve already determined the likely direction of the market. We’ve also found the best/worst sectors. Now it is time to find the specific names to trade. We don’t want to trade just any stocks, we want to trade in the most promising ones. Go through the stocks that make up each respective index. Those stocks should have the following criteria:

• Price – $40 and higher. Higher-priced stocks tend to have higher point moves than their low price counterparts. Ideally, one should trade these stocks, as these are what the institutions are playing, but these days there aren’t a whole lot of these stocks. Avoid lower-priced issues as they generally have smaller point moves. 
• Volume – The stock’s average daily trading volume should be at least 500,000 shares. 
• Range – A stock’s average daily trading range should be at least 2 points. The stock should be volatile. There isn’t much money to be made if a stock only has a ¼ point range.
• Trend – Longs should be in an uptrend as signified by a +DMI > -DMI. Shorts should be in a downtrend as signified by a –DMI > +DMI. Also, make sure that the ADX readings on these stocks are at least 25.
• Moving Averages – Longs should be above their 20-day exponential moving averages. Shorts should be below their 20-day exponential moving averages.

After looking at the component stocks of the PSE Technology Index, we identified a possible short candidate in Automatic Data Processing.The stock was trading under its 20-day average, the –DMI greater than the +DMI, and the ADX was 27. This signifies that the stock is in a downtrend.  The following week, the stock trades a little higher, but then drops 3 points.

Amerada Hess (AHC | Quote | Chart | News | PowerRating) looked to be one of the strongest stocks in the XOI.  It had most of the right criteria of a good long candidate.  It was trading above its 20 -ay average, the + DMI was greater than the –DMI, and its average range was a little above 2 points. In fact, the only drawback was that the ADX was less than 25. The following week, it trades about 5 points higher.

Conclusion

This simple method just serves as a general guideline to help you stack the odds in your favor. It helps to look at the big picture first and then work your way down. You’ll have a better understanding of the whole environment. By using a top-down approach, you’ll avoid being in a vacuum. Lastly, whatever you do, use a disciplined approach and don't just throw darts at a board. That way, you’ll put yourself one step closer to a successful trade.

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