The year was 2008 and the market was crashing hard. I was training to be a proprietary trader for a firm while I stared at a computer screen spewing out an endless stream of virtual ticker tape. I nimbly scalped pennies from highly liquid stocks in both directions. I was executing well over 100 trades per day using my keyboard like an expert gamer.
My confidence soared as I felt the pulse of the trades and rode the trend for a few seconds locking in tiny profits over and over and over. Even better, I was buying at the bid and selling at the ask which earned me rebate credits.
Then my manager looked over my shoulder and made a simple comment that changed everything:
“You’re missing the big picture. Where is the stock going?”
Where is the stock going? I wondered what he meant. I was exhibiting laser focus and trading micro-trends that lasted 30 to 60 seconds. What was he talking about?
Here was the problem: Half of my trades were long yet we were in the middle of one of the biggest down days and down weeks and down months in the recent history of the stock market. Yet there I was going long with tiny one-minute rallies.
My problem was tunnel vision.
I was so focused on a particular setup that I neglected to look at the bigger picture and put it into context.
Overcoming Tunnel Vision
How do you overcome tunnel vision? The answer is to look at a stock from a couple of different angles and a few different time horizons.
Now, I need to caution you as the other end of the spectrum is just as bad. Too much context can create paralysis from over-analysis. I also remember looking at websites that gave bullish and bearish readings based on dozens of indicators over multiple time horizons. It was mind boggling! For every buy signal there was also a sell signal. The glut of contradicting information led to indecision as you could make a case for both buying and selling.
How did I overcome tunnel vision? Here is the process that I use:
Fundamental Stock Screening
The core of how I trade is to use quantitative screening. This process gives me a large basket of stocks that, on average, have a higher chance of out-performing the market. I have a strong preference for small-cap and micro-cap stocks which have value, lower volatility, positive and growing free cash flows as well as other factors that usually mean more return and less downside risk. The stock needs a fundamental reason to go up before I will buy.
The next step I take is to look at a very long-term chart. I typically set the chart so that each bar represents a month worth of data.
This chart will usually span at least 10 years. At this point I just want an overall idea if the trend is up or down. I typically prefer to trade a small pullback but inline with the overall and long-term trend.
Next, I examine charts where each bar represents a week and a day. At this level I start to add a little more detail with some support and resistance levels along with various trendlines and maybe a channel – if it is obvious.
From here I really start to zoom in and consider actual trading signals. I will often look at hourly bars and 15-minute bars. Sometimes I look at 5-minute bars but that is usually only on the day that I actually want to trade. While I also look at 1-minute bars, I am also very wary of this as there are too many games and whipsaws that fake me out.
As an example, in the KO chart above with hourly bars, there is a possible long play if it bounces along the bottom trendline at $50.40 (or whatever the price is when they connect). If that trend is broken, there is no long trade. But will I go short if the bottom trendline is broken? That is where you have to put in all into context. Looking at the long-term, medium-term and short-term chart, I have no desire to be a contrarian on this one.
Does that mean I will never short this stock? Far from it. But as it sits today, this isn’t a stock I want to short. Maybe if short-term and medium-term and long-term trends were broken. And I might short after the stock shoots up for one last gasp of air as it hits the underside of a trendline. Again, this is all about context over many timeframes.
The point I am trying to make is to look at the stock from a few different angles to get a feel for different forces at play.
My process might not be the same as yours. You may not use fundamentals. You may choose to trade different time frames and ignore charts that span more than one year. That is your call to make.
Regardless of how you choose to apply it, I encourage you to take a step back and see the bigger, or possibly smaller, picture before jumping into your next trade.
Kurtis Hemmerling is a quantitative analyst who consults with family offices and one large global asset management firm. He is skilled in designing multi-factor equity models which take advantage of profitable anomalies found in the furthest reaches of the stock market. Kurtis has a particular passion for small-caps and micro-caps where alpha is abundantly available for those with the knowledge and the skill to extract it.