Monday, April 24, 2006

Profiting From Historical Studies of Individual Stocks

Most of my posts on this blog have focused on the S&P 500 Index, which is what I predominantly trade. There is no reason, however, why historical studies can't be applied to individual equities. Indeed, such research might have even greater promise than modeling the indices, since stocks can be chosen according to their volatility and trending properties.

Today's trade offered a perfect opportunity in Google (GOOG). The stock rose over 5% on Friday on volume that was 1.83 times its 20-day average. Stocks that have made large moves are especially good candidates for study, because volatility tends to carry over from day to day. On average, a stock that has moved well on strong volume will offer good movement the next day. If there is also a directional bias to this movement, a good trade idea is born!

It turns out that, since April 2005 (N = 254 trading days), we've had 14 instances of a one-day rise in GOOG that exceeds 3% on relative volume of 1.5 times average or greater. The next day, GOOG was up by an average 1.6% (11 up, 3 down). That's much more bullish than the average one-day gain in GOOG of .34% (149 up, 106 down).

Sure enough, when we got selling in GOOG during the morning--but could not make new lows vis a vis Friday--the trade idea paid off well. I'll have an article in Trading Markets shortly outlining the trade and some lessons from it.

The moral of the story, however, is that it pays to be flexible in what one trades. Even in a low volatility S&P market, there can be excellent trading opportunities in individual stocks and, of course, outside the equity universe.