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There are two basic ways to screen for possible trading opportunities.

The top-down approach or the bottom-up approach.

Both of these can be used to find either fundamental-based trades or technical-based trades.

In the chapter we will discuss how to use each way to find trades based on the fundamentals.

With the top-down approach, you start with high-level market analysis. You look at all the types of markets (equities, commodities, currencies, etc) to decide what shows the most promise. When equities are on a bull run, for example, it is always better to go long in stocks.

Even if you only want to trade equities (or whatever) you will still do this high-level analysis because all the markets are correlated.

From there, you drill down into specific industries. When going long, look for those industries that are leading the pack.

Finally, you will examine individual securities within the leading industries.

The top-down approach gives you an understanding of the overall market. This is useful because most securities follow market trends. If you trade with the overall flow of the market in a leading sector then the specific stock you choose is much more likely to trend in a favorable direction.

When you size up the market your goal is to determine whether the overall maket is cheap, fairly priced, or expensive. In general, you always want to trade with the direction of value.

If the market is cheap, going long is best. If it is fairly priced, range trading might be a better strategy, and if it is expensive, go short or stay out of the market.

However, just because the overall market isn’t cheap doesn’t mean you can’t go long. Use the knowledge of the overall market sentiment together with price action to help you make more informed decisions when you trade.

There are several ways you can determine the market's overall trend such as using the long-term P/E ratio, the FED model or others.

Sam’s Note: Fortunately, these days you don't have to do all the calculations yourself.

The easiest way to know what the overall market is doing is to Google it! Check several reliable sources to see what the overall consensus is.

You can also check out www.Finviz.com. Underneath the three graphs at the top of the screen there are several little boxes. The more green you see, the more bullish the market.

The industry a company is in is one of the major determining factors of relative success.

A company within a strong industry is more likely to see positive growth.

When looking to buy, search for industries that have a low price to free cash flow ratio that is still above zero. This metric measures the amount of excess cash the company generates.

You can also look for industries with the highest earnings growth rates that are trading at the lowest valuation.

Sam’s Note: There are ways to dig deep into industry fundamentals, but just like with market analysis, many professional analysts have already done the hard work for you. Follow their lead.

My personal favorite way is to go to https://www.investors.com/ibd-data-tables and then click on ‘Industry Group Rankings.’ Look at the top three industries as well as the top industries that have been steadily ‘climbing the ladder’ to the higher positions.

With the bottom-up approach you start at the individual company level and then work your way up.

This approach will suit you if you favor fundamental analysis over technical analysis or are looking for trades going against the overall market, such as going long in a bear market.

The bottom-up approach starts with a screen, which is a way to filter out specific securities based on criteria of your choosing.

Sam’s Note: A good free screener is www.Finviz.com. https://finance.yahoo.com/research-hub/screener is another option.

A good way to structure your screens are to search for either growth stocks or value stocks depending on which is more in favor. You can determine this by plotting a ratio chart of a growth and value index.

When you enter your screening criteria, your aim is to capture companies from several or more industries. If one industry is very dominant, your criteria is probably too strict.

Here is a sample criteria for a growth screen. Use it as a base and then tweak it to your liking. It assumes you want to trade long.

• Share Price: Over $5. This screens out low-priced stocks which are more prone to market manipulation.
• Average Daily Volume: Over 100,000. This ensures the securities are liquid so your orders will get filled.
• Earnings Per Share Growth: Over 25%. Ensures the company is growing.
• Annualized five-year historical EPS Growth: Over 10%. Also ensures the company is growing.
• Relative Strength: Over 80%. Ensures price performance in the top 20% of the market.
• Return on Equity: Over 18%. Ensures growth is fuelled by management effectiveness and not just industry fundamentals.

Here is a sample criteria for a value screen. Use it as a base and then tweak it to your liking. It assumes you want to trade long.

• Share Price: Over $5.
• Average Daily Volume: Over 100,000
• P/S: Under 1.25. Ensures the company is undervalued.
• Dividend Yield: 1% - 10%. Most value stocks pay a dividend, but you don’t want it to be too high.
• Relative Strength: Over 80%.
• Return on Equity: Over 18%.

After completing your screen, you need to rank the securities by some measure so you can focus on the most promising ones.

One way to find good securities for long trades is to rank them by their P/E ratio from lowest to highest.

Now look for a security that has strong earnings, a low valuation, and is in a well-performing industry.

Swing traders are generally top-down investors, but that doesn’t mean you can’t be bottom-up if you prefer.

Both methods work as long as you are good at the one you choose.

Choose one method and stick to it.

Read the next chapter here.

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