Using Probabilities and Sector Analysis to Spot Profitable Trades
Pat Anderson is a full-time trader who looks for short-term trends in stocks and ETFs to find profitable trades. Here, Tim Bourquin of Tim Bourquin talks to Pat about the charts he uses and how he screens the market for the basket of stocks he is going to watch for the day.
Tim Bourquin: So tell me, what kind of trader are you? What markets do you trade?
Pat Anderson: I trade stocks and occasionally ETFs but almost all stocks, and the thing that I go after are trends. I think of myself as a trend trader, and I look for trends primarily on daily and 30-minute charts and try to find some opportunity in each of those. Some days I find a lot and other days not so much. But I stay patient and wait for good trades to present themselves. When I’m looking at the 30-minute charts as a guide, I’m looking for “ripples” in the chart.
Tim Bourquin: What do you mean by ripples?
Pat Anderson: I’m typically looking at a one-month-wide chart of 30-minute candlesticks. Those are the types of charts I’m able to spot trends on most easily. What usually happens is that a stock or ETF will trend for a while, then rest in a channel or pullback, and then trend again. Those “ripples” between trends are where I look to enter and take advantage of a rest in the trend before it continues again. It doesn’t matter if it is a down or uptrend – either one can be traded with short or long positions. The pullbacks generally offer the best opportunity to get in, assuming the stock doesn’t pullback so far that traders give up on the original trend and now look for it to change to the opposite direction.
Tim Bourquin: Is there a particular type of stock that you like to trade?
Pat Anderson: I screen for highly liquid stocks that are institutionally owned. They’re all NASDAQ and New York Stock Exchange listed, and they’re mostly the ones that you hear about in the news on a regular basis. I stay away from penny stocks or stocks with low volume because those are difficult to find true trends. My screens cut most everything off at five dollars and about 500,000 shares average volume per day, but I also weed out a lot of ADRs just because they tend to gap on the open and don’t give you much of a trend to work with during the day.
Tim Bourquin: You’re a former engineer – did that career help you as a trader?
Pat Anderson: If you’ve seen my Twitter messages, they are all about statistics. I use statistics as another type of screen to find good trading opportunities. For example, I might screen for stocks that are above yesterday’s high and below yesterday’s low because statistically it is a great way to find an early indication of a beginning trend. I also look for new highs for several different time periods. If a stock is above yesterday’s close and also today’s open early in the day, statistically it’s a great indication that it will be in a nice intraday trend for the rest of the day. As a former engineer, I try to approach the market in a very objective manner. I also wrote the software I use to screen the market so my experience as an engineer was obviously helpful in that regard. However, I also had quite a bit of risk aversion when I first started trading so in that sense my background may not have helped. But anyone can use statistics to look at the market in an objective way and find opportunities. Find things that have a high-probability of repeating themselves and use those probabilities to make trading decisions. But even I have to remind myself that I can only do so much research and then it’s time to trade. Nothing will ever be one hundred percent sure.
Tim Bourquin: What are those high-probability things that you look for?
Pat Anderson: Some are quite simple. The one we discussed already is a pullback on an intraday trend. If a trend has established itself intraday and pulls back for a bar or two, the probability is that it will continue that trend after a short rest. It doesn’t always happen, of course, so you need to have stops in place. But I focus specifically on stocks that have trended well intraday in the past. For example, in their previous two or three up legs they have trended well intraday. You can use most any off-the-shelf back testing software to look for these things. You can often spot stocks that, in the past, have jerked around in consolidation and then rip upwards and those things tend to repeat themselves.
My strategy really boils down to this: I’m interested in trends and consolidations that have a great potential to continue. If I believe a sector is about to move up, then I will look through all of its most-liquid stocks, look at the 1 year daily chart to see which moved the best during the last two or three of its previous legs upward in the same direction. My goal is to work the list down to five or six of the strongest stocks. Then it becomes a matter of looking at the quality of the trends in the past, how it reacted to various technical signals and then make a choice of which one of those five or six to trade. Finally, I’ll look at five-minute bars for that stock and enter when it crosses above an area of resistance such as the previous day’s high. Particularly if it crosses through an area that it has had trouble breaking in the past – that’s an excellent sign.
A bull-flag or bear-flag pattern is also good to see. Those typically indicate a move is ready to happen.
Tim Bourquin: How about other indicators? Do you use anything else on the chart, Stochastic or MACD, anything like that?
Pat Anderson: There are a lot of moving averages all over each of the charts. I do monitor those because those are where traders tend to line up with their orders. I don’t make trading decisions based on those specifically, but I know other traders do so I keep an eye on them. On a 30-minute chart, for example, traders seem to watch the five-period moving average closely and I can “see” them lining up either right under or right above with their orders so it’s important to watch. The only other indicator that I use is the 2-day RSI on a daily chart, and I do like that. I’ve studied it quite a bit and it’s just another piece of pullback information for me. It’s just a stretching indicator but only when the stretching is extreme.
Tim Bourquin: What do you mean by stretching indicator?
Pat Anderson: If a stock runs 10 days in a row, for example, and seven of those 10 days, it moves more than most of the past 30 days, chances are the stock is probably reaching the end of that run. Every move has a finite life and it’s just natural that the stock will pause, pullback and then resume that move. Or, if it breaks certain levels on that pullback, such as making lower lows, it’s time to change sides and play the other direction. If you begin to see shorter candles three days in a row accompanied by even slightly lighter volume each of the three days, that’s a good sign that a stock has exhausted itself on the move and is ready to rest or retrace.
Tim Bourquin: You mentioned using a lot of moving averages on your chart. Which ones are your favorites?
Pat Anderson: On a daily chart, I like the 8 and 20-period exponential moving averages and also the 50 EMA. For big picture trends, I also like to watch the 89-period EMA and the 200-period simple moving averages. But again, I never make a trading decision based on the moving averages. They are simply a tool I use to see where other traders are lining up with stop loss or breakout-play orders. I look at them as an influence on other traders – nothing more.
Tim Bourquin: Does news figure into your trading at all?
Pat Anderson: Not really. I pay attention to what’s going on, but ultimately I’m a pure technician. I find that the news tends to play on my emotions too much and I try to keep emotions to a minimum whenever possible. All the information I need is in the chart and by looking only at the technicals, I can be more objective about the trading decisions I make.
Tim Bourquin is co-Founder of TraderInterviews.com, a website where he discusses trading strategies and methods with all types of successful active traders.
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