How a Veteran Looks For Ideas #1

The first instalment of the idea generation series from The Veteran.  

I am often asked how I find ideas in the markets;

• What sources of information do I use?

• And what do I look out for?

• Am I technical or fundamental in my approach? etc etc.

To be honest it’s not easy to distil thirty years of experience, trial, error and learning into a concise answer.

Especially if you are not sure that you and the reader are speaking the same language.

I don’t mean that to sound patronising.

When you do something every day for the majority of your adult life you take a certain amount of knowledge and understanding for granted, sub-consciously leveraging experiences and things you have learned along the way.

But let’s give it a try.

More buyers than sellers - This is often used as a slightly sarcastic response to inquiries from market reporters or retail customers as to why a share price was rising (or if falling, more sellers than buyers).

However, the comment does encapsulate the main drivers of price change, namely supply and demand.

Watching changes in those two metrics can tell us a great deal about potential future price action, so I watch several metrics related to those changes.

Volume traded - there are two volume metrics I like to watch closely. In fact, there are more but we will focus on two for today.

First of all, the volume traded - literally the amount of volume traded in an instrument over a fixed period. Usually a day but it could be shorter periods too.

Either way, what we are looking for is the trend in volume, is it rising or is it falling?

Perhaps more importantly, what’s happening to the volume traded relative to price change?

90% of the time I want to see volume and price moving concurrently.

I want to see volumes growing as the price moves.

The bigger the move the bigger the volume should be if I am to buy into that price action.

However, there are times when its good to see a sharp price rise or fall without decent volume.

That can tell us that it’s likely a false breakout or that price is being squeezed and liquidity has dried up.

One way or the other, the only way for that lack of liquidity to be resolved is for the price to find a new equilibrium level that tempts in both buyers and sellers who are happy to transact freely with each other.

The other volume metric I watch regularly is the percentage of the average daily volume being traded today.

Average volumes tend to be calculated over 20 or 30 days and on a rolling basis.

By tracking that number and comparing the current volume to it, we can see how the instrument is performing relative to history, and we can also see how a group of instruments are trading relative to each other.

For example, the chart below tracks the FTSE 100 stocks and plots their percentage price changes against the percentage of ADV (or average daily volume) traded.

That allows us to look for outliers among the group, something that I have always believed is key to idea generation.

If you want to take this one stage further you can endeavour to track how an instrument is trading in relation to price and volume metrics such as VWAP or VPOC.

I tend to favour VWAP (the volume-weighted average price) as I have access to that metric and I have used it for many years.

In this hourly chart of Harley Davidson we have the price line in black and the volume-weighted average price of VWAP in purple.

As we can see the price line is trading ahead of the VWAP;

I see VWAP as a measure of the impatience of the market to be in or out of an instrument.

If VWAP and price are trading in line with each other then the market is being patient or biding its time.

But if price starts to run ahead of VWAP in either direction then the market is being impatient in its desire to buy or sell that instrument, which increases the potential for an outsize move in the price of that instrument.

The longer that imbalance persists, the bigger the opportunity for an outsize price move will be.

In this instance, HOG fell by almost -4.75% on a day when the S&P 500 fell by just -0.40%.

Next time we will look at the models and screens that I find useful and informative when it comes to looking for ideas.