David’s Five Keys to Identifying a Fundamental Day Trade

February 2, 2010

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In the Oxen Group section, David recommends a couple day-trades, usually in the morning, often a stock or ETF to buy, and a stock or ETF to sell short. David selects his trading candidates based on his “fundamental day-trade system,” and his analysis of the technical condition of the market. He attempts to choose stocks and ETFs that are likely to move 3-5% during the day, and also to open and close the positions at optimal times.

David selects trades by first examining five key sources of information to help him find "high probability trades." After selecting the trades, he applies several basic trading rules. He has an excellent track record, which is posted in the Oxen Group section and updated every few weeks. Previously, David wrote about the first two of his fundamental keys. Here, David writes about all five of the most important factors he looks at. – Ilene

The Five Keys to Identifying a Fundamental Day Trade

By David at Phil’s Stock World

Identifying the Fundamentals

Stocks move under the influence various factors that we can use to identify stocks that are likely to move 3-5% in a single day. Even the best technicals seldom give you 5% upward (or downward) movements intraday alone, but combined with fundamental factors, we can find stocks that are likely to make these large daily moves.

To begin to seek that perfect stock or ETF, we first need to look for something that can propel a stock or, in the case ETFs, the represented sector. This 3-5% movement is not from the previous day’s close, but between the market’s open and close. We want to identify a stock that can be bought sometime in the morning to give us that significant movement by the end of the day. The first type of information that is prone to easily move stocks is earnings.

1. Earnings

There are multiple ways to play a company’s earnings. One of the most effective ways to invest based on earnings is after a company has already announced their earnings. We are looking for earnings that were surprising, especially ones that say something about a sector.

For example, if one company announces positive earnings because it had a large profit from a lawsuit, this information does not tell us much about the earnings potential of the sector in general. However, if an important company in a sector has positive earnings due to an increase in sales or because it saw higher demand than anticipated, this information is more telling of its sector as a whole, and the news may move many similarly situated stocks.

We like the sector-telling earnings because it suggests something about the sector is most likely bullish (or bearish). For example, if Burger King Holdings Inc. (BKC) reported earnings and noted that they were seeing increased demand for fast food because customers were cutting back on more expensive restaurants, this would suggest a general transferring of food money from high-end restaurants to fast food. This information should propel not only BKC, but also McDonald’s (MCD) and Wendys/Arbys Group (WEN). The positive earnings may benefit companies that are closely related to the reporting company. Typically, we do not want to invest for a single day-trade in the specific company that reported the earnings. The reporting company is likely to gap up the next morning and have less room to run due to the large jump up from the closing price.

Instead, we look for competitors that will profit from the good news. Take for example, J. Crew Group Inc. (JCG) and Gap Inc. (GPS). On May 28, 2009, J. Crew, in after hours, announced earnings that significantly exceeded estimates when it reported an earnings per share at 0.34 EPS. The street was estimating 0.11 EPS. This was seriously bullish news for JCG. The next day the stock jumped 26.4%. The stock gapped up so heavily that traders jumping on in the morning missed most of that movement. So, in the morning, the Oxen Group recommended Gap Inc., a close competitor of JCG, especially with their Banana Republic line. On the same day, GPS moved up almost 5%. The Oxen Group was able to get in at the beginning of the day while the stock was still at a low price, and then ride the wave upwards.

We find that earnings releases can be used to make gains on competitor companies because the competitors’ stock often reacts slower than that of the company releasing the earnings. We look for competitors that have similar product lines. The same is true in the reverse direction. If a company bombs estimates, many similar companies will be pulled down with it, providing us with a good shorting opportunity.

Additionally, extremely good earnings in an important company within a particular sector may suggest a day-trade with an ETF that models the sector. In the case of JCG, related retail ETFs are sparse and have low volume, not the best vehicles for trading. But with an energy or financial company, sector ETFs are heavily traded, and playing an ETF the same way we played Gap could be very profitable.

In summary, earnings can be a very solid fundamental bull or bear signals for a single day-trade. However, earnings do not come out everyday. Where else can one look when trying to identify a bullish or bearish fundamental trade for the next day?

2. Upgrades/Downgrades

Upgrades and downgrades are extremely powerful mechanisms that can propel a stock up or down significantly. Ratings can move a stock up or down anywhere from 1% to 10% depending on the rating company’s significance, the ratings change, and the company being rated. Moody’s, S&P, Credit Suisse, Goldman Sachs, Morgan Stanley, and Fitch are rating companies that are particularly significant. Smaller equity firms tend to have less impact on a stock’s next day movement. Upgrades and downgrades typically come in the morning or intraday. However, when they do come in the evening, they work in the same way as earnings – an upgrade can give rise to a sizable stock movement.

An upgrade or downgrade will have a strong effect on an entire sector if it has something to do with the broader picture. If a company gets downgraded because of risky investments or bad credit, it is not likely to bring down its competitors. However, if the downgrade is due to lower sales expectations, its competitors are more likely to trade down in sympathy.

For example, on Saturday, June 6, 2009, Torchmark Corp. (TMK), an insurance company, was downgraded by Fitch Ratings for bad investments as well as a sector wide decline in the ability for insurance companies to be profitable in this market. All the insurers ended in the red, most likely due to the questioning of insurance companies’ profitability in general. Obviously, a multitude of factors go into companies within a sector, but upgrades and downgrades can be very significant in predicting the movement of single stocks and sectors.

3. Foreign Markets

Another way to gage how well a stock may do the next day is to see what is going on in foreign markets. Typically, this will have the most impact on commodities, such as oil, and products that are sold overseas or overseas companies that have a PLC or ADR on the American stock exchange system.

For example, oil, oil and gas stocks, oil and gas ETFs, and anything that has to do with oil will be affected by changes in the price of oil. What the oil market is doing overseas can be a great fundamental predictor of what the oil sector will be doing when our markets open.

For example, if the oil inventories are skyrocketing in Asia, demand is down, and the price of oil plummets in the Hang Seng and Nikkei, this will have an effect on the NYMEX. In our globalized world, what happens in one country affects us all. If oil demand is dropping in China, any company connected to selling gas or pumping oil out of China will be impacted by the demand drop. The price of oil will be affected negatively, which will in turn negatively affect other oil companies, oil producers, and ETFs.

The same is true, in reverse. On June 1, 2009, The Oxen Group recommended Toyota Motors Corp. ADR (TM). The company, in Asia, had skyrocketed due to booming Prius sales in Japan that were significant in Japan’s extremely weak consumer economy. Therefore, if Japan was able to do well with the Prius, one might conclude that while the car may not have done as well in America, it was bullish news that would positively affect the ADR. It was not so directly bullish, however, that it would send the stock up 5-6% out of the gates, and we would never have a chance to buy in. The stock did gap up, moved back, we were able to get in and make 2% off the ADR for the day.

4. Financial News

News can come in many ways and can be fundamentally bullish or bearish. Often, big news stories comes out intraday and move stocks so quickly that the opportunity is gone by the time you see it. Though intraday opportunities may vanish as quickly as they arise, investors should be looking for news after hours that may be significant enough to help a stock or a sector, as a whole, the next day.

For example, one of my favorite pieces of news to use to invest is box office weekends. The company that owns the movie that wins the box office tends to have a very good day on the Monday after that weekend, especially if the movie’s success was extremely bullish and surprisingly. For example, on May 29-31 "Up" won the box office and it was the third largest revenue maker for a Disney-Pixar animated flick, coming in way above estimates. It sent the stock up a solid 4% on that Monday simply based on that fundamentally bullish news. On June 5-7, "Up" retained the top spot but the news was less significant. Disney ended June 8, 2009 without the 4% gain and finished sideways.

News has to be significant to truly propel a stock. However, if the news is too large and too visible, the stock may jump too fast to buy it at a good entry point.

One of the interesting ways to use news is with a sector ETF. For example, if on a given day, in after hours, three or four major financial companies have some bearish news, it may be a good time to buy into an inverse ETF that will move in the opposite direction to the financial sector in general.

In trading news, however, be careful. It does not always have the effect you expect.

5. Futures

The final key telling-signal of fundamental bullishness or bearishness is the futures market for the Dow, S&P, and Nasdaq. These markets open at 12 AM on trading days and trade until the start of the session. The futures markets can give an investor a general sense of market direction.

For example, suppose you are excited about Dryships Inc. (DRYS) because the shipping indexes are jumping up significantly in Asia. At the same time, though, the futures are significantly in the red for the coming trading day, due to a multitude of bearish news and earnings that were reported the afternoon and night before for the American market. This could really hinder DRYS’s movement the next day because the market is in the red.

In the reverse, futures can help you feel more confident that a stock with fundamentally bullish indicators could continue upwards when the market is looking healthy. Futures are a helpful indicator to determine if a stock will be a good or bad day trade; they’re definitely worth considering.

So, there you have it — the five fundamental indicators to help you identify the perfect day trade. There are a number of other indicators that go into any trade. Technicals are very relevant, the entry and exits are important. The fundamentals are the start of the ability for a stock to move up. The patterns that were identified in the piece should help you find and search out stocks that would be bullish.

Everyday, the Oxen Group chooses our Oxen Picks starting with the ideas above.

The final piece of advice to keep in your tool belt is to stay confident in your picks. If you have done the research and the evidence is there for the stock to move up, then you should feel confident that your ideas will work. If it does not work to perfection, it is okay because if you keep identifying fundamentals, it will work more often than not.