The Microcap Speculator

I’m adding the latest incarnation of Tim Knight’s blog, Slope of Hope, to the blogroll on the right and would encourage all to take a look. The name says it all. Tim, unabashedly ursine, takes square aim at the permabull slogan of markets climbing a wall of worry.

Tim’s blog is especially fitting for our times. As the markets hover just under recent highs, but become more and more narrow, it is critical to keep an eye on the deterioration. Tim does that one chart at a time. His approach is wholly technical, and he brings strong credentials to the table. Tim founded charting service Prophet.net, now part of InvestTools, and is the author of Chart Your Way to Profits. Unlike many chartists though, the charts on his blog are not cluttered with a host of indicators. Instead, Knight keeps his charts clean and focuses on tried and true techniques like support and resistance, trendline breaks, and retracements. See for example this recent chart showing the breakdown on the semiconductor index, and identifying a retracement to the neckline as a positive risk/reward entry for shorting:

My approach blends fundamental and technical analysis, so you may question why I read a blog that rejects the fundamentals in favor of a 100% technical approach. The answer is simple: I want to learn all I can from the best practitioners of both methods. Tim Knight, like my friend Suri Duddella, certainly falls in this camp.

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Some of my favorite stock blogs are featured on the “visit” category to the right, but that list desperately needs an update. Starting today, I will begin to add more links to financial blogs that I think you will enjoy.

Today, I have added a link to Stock Bee, a blog by Pradeep Bonde demonstrating that effective quantitative systems need not be complex or intimidating. In fact, as Pradeep recognizes, many of the best are simple in both design and execution. The premise is not popular with many system designers, who tend to look down on any system accessible by those without PhD’s in mathematics or rocket science, but I think it is correct. Pradeep’s systems are not specifically designed for microcaps, but many (like Double Trouble) could be easily modified for that purpose. I also like a system he developed to trade the IBD 200.

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One huge benefit of trading microcaps is that they are less correlated with the S&P 500 or the DJIA than their larger brethren. However, microcaps will not escape strong moves like February 27 unscathed, so traders still need to keep one eye on the big picture. Here’s how I do it:

First, I follow the market commentary on Bill Cara’s blog, RealMoney and Minyanville. On good days I read it all; when busy I may do no better than scan the entries at night. Those traders are incredibly bright. If you have access, take advantage of it.

Second, I track an indicator I call “Combined Breadth.” It simply plots a histogram of (# NYSE Advancers + # Nasdaq Advancers - # NYSE Losers - # Nasdaq Losers). I omit Amex, mostly because I don’t trust that exchange. Yeah, I know Combined Breadth is not going to win any programming awards, but it works for me. Take a look at it on the hourly chart of IWM (Russell 2000 ETF) above. From 2/21-2/26, when IWM and many other index ETFs were hitting new highs, the indicator showed that the majority of stocks were actually declining. I used that information to partially hedge my microcap exposure with short Russell 2000 positions, which were covered on 3/2 (because I had a plane to catch not because I was prescient). This move helped minimize the decline in my overall portfolio during the recent market dive.

Third, I keep a quote window of about 350 stocks that are now or recently have been part of the IBD 100 index, my proxy for high beta. This window is for glancing only. If its mostly green, and lots of 5+% winners, the market is likely to close high and could move significantly. If its a sea of red, fasten your seatbelts. I just ignore mixed pictures, like the one to the right.

(This is the third in a series of articles on the tools I use for my research and trading. The first installment discussed tools for finding microcaps with dividends and the second installment discussed tracking institutions and insiders.)

DISCLOSURE: I have no position in any of the stocks mentioned. Not a recommendation to buy or sell any security. For informational and educational purposes only.

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Yesterday I stumbled across The OTC Speculator blog. It’s well written and frequently updated. I don’t know a thing about most of the stocks he covers, but that’s the beauty of microcaps…finding the nuggets of gold amidst the mountains of pyrite. Take a look.

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