Why sentiment matters in stock selection
One of the first things I look at when evaluating a stock is its price chart. I know a good-looking chart when I see one: it's a steady, uptrending line moving from the bottom left of the chart pane to the upper right, without huge jumps up and down. The problem is that there are thousands of stocks and I can't look at every single chart. So, I came up with a method for quantifying and ranking a stock's chart based on what I'm looking for. This week, I'm going to explain my method and list the best-looking charts so far in 2018, and I'll quantify how this method would have performed in the past as an indicator.
4 Data Points for Objectively Strong Stock Charts
To come up with a chart score, I use four pieces of data for each stock:
- The year-to-date return.
- The percentage of positive days.
- The maximum year-to-date drawdown for the stock.
- The standard deviation of daily returns.
I weighted the year-to-date return more than the other components of the score. Combining these four statistics, I came up with a way to objectively rank a stock's chart -- something usually subjective.
Top 30 Stock Charts of 2018
Below is a list of the top-rated stocks so far this year, based on the methodology above. Eyeballing some of the charts, I must say my stock-chart scoring system is a handy tool for finding the type of charts I like -- a line moving higher from left to right at a 45-degree angle.
Quantified Chart Score as an Indicator
I looked at how stocks performed last year based on these price chart scores. Specifically, I looked at liquid stocks around this time last year and broke them into three brackets based on the scores. Then I summarized the stock returns for the rest of the year. The table below shows the results.
Well, as a standalone indicator, the chart score does not seem to work. The stocks with the lowest chart scores averaged a 16% return over about the last half of the year. The best scores averaged only a 9.3% return. Those returns for the worst scores, however, came at a price. They were extremely volatile, as you can tell when comparing the standard deviation of returns. Also, just 67.5% of those stocks were positive.
The best charts, which averaged a lower return, had a much better chance at being positive. Just over 80% of the stocks with the best charts were positive through the rest of the year. While the stocks with the best scores didn't have the highest average returns, they seemed quite a bit safer based on this data. So, that's something.
Why Sentiment Matters in Stock Selection
But what if I took the best scores and layered on some sentiment data? One common sentiment indicator we examine is analyst recommendations. Using the stocks from last year that had the best chart scores, I broke them down into three brackets based on the percentage of analysts that had a "buy" recommendation on the stock.
If you look at stocks that have a high chart score and combine that with very few analysts suggesting "buy," you get an ideal contrarian buy setup; a stock that resiliently moves higher despite negative sentiment. The table below shows how the stocks performed when you layer on the sentiment data.
These ultimate contrarian setups were near slam-dunks. They averaged a 12% return for the rest of the year, and even more impressive than that is about 95% of the stocks were positive. The total number of returns in the table do not equal the 77 returns from the previous table in the "Best Charts" column, because in this table I only considered stocks with a minimum of eight analysts.
10 Stocks for Your Watch List
The obvious question now is -- which stocks in that first table (Best Charts of 2018) show negative sentiment based on current analyst data? The table below shows the stocks that have the best-ranked charts this year, yet no more than half of analysts rank the stock a "buy." This would be a very good list of stocks to do some further research on as potential buys for the rest of the year.
