STP Algo Trader - The Method

Welcome to the latest issue of STP Algo Trader "The Method"!

Every Saturday, we will break down each of the inputs that go into our proprietary algorithmic trading system - Signal Trader Pro.

Not only do we want to share the inner workings of our system, but we want to educate you on how to become a better investor. Remember, our ultimate goal is to help you MAKE MONEY!

Last week, we did a brief review of the components of our system, focusing on the price and liquidity metrics that make up the "6" of our "15" points. This week, we will briefly review the components that make up our fundamental or operating analysis, which makes up "9" of the "15" points.

We are also happy to announce that we have completed the development of version 2.0 of the system. Let us start by saying it ROCKS!

We will begin the full rollout of that system version after the July 4 holiday.

Most of the components of that system are the same, but we have made a few minor changes in the point system.

More importantly, we have added a trading overlay that significantly improves the hit rate, alpha generation, absolute return, AND downside protection. It is an absolute home run!

Version 1.0 – which we have been running for the last year – has truly been a “beta” version. This new Version 2.0 is ready for prime time.

We are incredibly excited to introduce it to you all.

The fundamental and operating contributors to our “15” point system break down into three types of analyses across three different metrics.

The three metrics are sales (REVENUE), cash flow (EBITDA), and earnings (EPS).

We did a deep dive into why we use all three of these metrics in this note.

We go into great detail in the note on why we use all three metrics, but the idea is that the companies that are "winning" on all three metrics are the most attractive to investors. This makes them even more attractive stocks on a pullback.

If we had to have only ONE metric score amongst these three for most companies, it would be the earnings (EPS). For a few companies, it is the cash flow, but both are the most powerful metric for most stocks.

Like we said, though, why not look at ALL the metrics and try to find the very BEST companies?

Points 7, 8 and 9 – GROWTH

The first analysis we look at is the year-over-growth on a quarterly basis for each of these three metrics.

We want to see positive year-over-year growth. The data supports that investors value growth more than any other variable, so year-over-year growth on a quarterly basis is a sign of an attractive stock.

We go back and look over the previous 12 quarters and are looking for the company to have achieved positive year-over-year growth in at least 75% of the quarters.

For each of the three metrics where they achieve this, they receive "1" point. A company that has grown 75% of the time for the last three years of quarters will receive all "3" points.

Here is an example from a recent HX Trader idea – Fiserv, Inc. (FI) – showing a company that achieved all “3” points…

We discussed these qualifications in this note.

Points 10, 11 and 12 – SURPRISES

The next analysis that we will examine is how the company performs on these three metrics relative to analysts' expectations.

Companies that do better than what analyst are expecting will usually see their stocks go higher. Companies that miss analyst expectations will be punished. This is one of the most powerful relationships in the stock market.

We use a similar test as we do for year-over-year growth. To earn a point, we are looking for companies that have beat expectations at least 75% of the time over the previous twelve quarters.

Here is the chart showing this data for FI…

We discussed these qualifications in this note.

Points 13, 14 and 15 – REVISIONS

Finally, we look at analyst earnings revisions.

Wall Street calculates a "consensus" estimate for each of these metrics by taking the average of the estimates for each of the analysts that cover the stock. Remember that each of the stocks in our universe has at least six analysts who cover the stock.

Companies that see these metrics consistently revised higher will see the strongest stock prices.

The relationship between positive revisions and higher stock prices is by FAR the most powerful of any operating relationships we examine.

In fact, if we ONLY had the RSI ENTRY SIGNAL and REVISIONS for earnings – we think we could capture the majority of the system's value.

Again, though, why go for only some of it when you can go for all of it?

With REVISIONS, we are looking for an upward slope in the estimates.

Here is an example of the REVISIONS chart for EPS for FI…

The chart shows that the stock price has followed the EPS revisions.

Like the other metrics, a stock gets "1" point for each of the three metrics with a positively sloping chart of estimate revisions.

We discussed this analysis in this note and this note.

This completes our review of the basics of our "15" point system that drives Signal Trader Pro. Combining these measures allows us to identify the highest probability and return opportunities in our large universe of stocks.

Beginning next week, we will introduce you to the new Version 2.0 of the system. We can't wait!