Mark Minervini part 2
After reading part 1, you have what it takes to find/screen for stocks that follow Minervini's principles and what mental traits you should have. The next step is to find out how to use these screened stocks.
Once Minervini has found stocks according to his criteria, he uses charts, volume, and other indicators to assess what phase the stock is in. These phases tell when to buy and sell. You want to buy stocks just before they reach "stage 2". According to him, all stocks have 4 phases/cycles, and you should only be invested when a stock moves up with momentum in stage 2.
The 4 phases all stocks go through
Stage 1 - Consolidation:
Not much happens here. It can be in periods where a company has "weak" fundamental figures, there is uncertainty about the future of the company or the industry it is in, there are poor global stock market conditions, etc. It is a period when the company/stock does not have anything to attract larger funds and institutional investors to invest. The volume is relatively low during this phase, and it can last anywhere from months to years.
You should avoid trading stocks in this phase no matter how tempting the fundamentals seem to be. Wait until the price moves to phase two. You want to avoid getting stuck in a "dead" stock when in the meantime you could invest in other stocks that are in a clear uptrend.
Stocks that are in phase one usually have similar characteristics: the price goes in a "sideways" pattern and is constructing a "base pattern".
Stage 2 - Accumulation
A move to phase two often starts with little to no announcement or news. One thing is for sure, a transition to phase two takes place with a significant increase in volume and the stock is traded with high demand on days moving upwards. The volume will also decrease during declines. There should always be a rally with an escalation in price up to a minimum of 25/30% distance from the "52-weekly high" before you conclude that phase two is in motion and that you should consider buying.
Typical characteristics of a developing phase two are: the criteria in his screener explained in part 1 are assembled, you see a series of "higher highs" and "higher lows". There is high volume on large weekly closes, and low volume declines. There should be more weekly closings showing an upwards trend than a downward trend.
Such changes to phase two can also come from surprisingly fundamental news such as; promising prospects for the industry, good quarterly figures, new management, regulatory news, etc.
You now have the wind in your back and the share price is escalating upwards with good momentum, often "backed" by institutions, positive fundamental news, and more. You will then see large volume bars in the charts, often with clear "break-outs" from the consolidation patterns formed in phase one. The share price may have already doubled by this time, anyway, this may just be the beginning of a "Super Performance". If the company continues to deliver good fundamental news and growth, there will be increased publicity and even more demand for the stock.
Stage 3 - Topping
But as with everything else, all good things will one day come to an end. Stocks can not go up with momentum in eternity. The increase in earnings and growth may begin to stagnate, or the stock may technically begin to reach a saturation point. Either way, the stock price may go even higher, but you will see greater volume on the declines and increasing volatility. During this phase, the stock is no longer under extreme accumulation, instead, The stock shifts from strong buyers to weaker hands. Those who are often referred to as "smart money" will ease their amount of shares during the last signs of strength in the stock price. You thus get a "topping" pattern, eventually, you will get a "breakdown" and the stock ends up in a downwards trend.
Characteristics will be things like increasing volatility, large one-day declines on high volume, this volume is often higher than all volumes seen during the entire phase two rise, the share price goes below MA200, MA 200 will have a flattening to a downwards trend.
Stage 4 - Downwards trend
What was once an upward trend has peaked and has now become a downwards trend. Here you often see that EPS and sales have lost momentum, and may have gone towards a negative trend. The company may have missed its earnings results compared to what was predicted, or the outlook for the company may look unclearer.
There are many things that can impact a company to not have an equally promising future. During phase 4, the stock price is thus sold down over a long period until it is totally "oversold", and can return to a consolidation phase again (phase one), or go bankrupt.
If the stock returns to phase one, it may again take a long time before the company returns with accelerating growth and earnings, and as mentioned, a stock in phase one may be in this phase for a long "dead" period.
Phase 4 is in many respects the opposite of phase two, with higher volume on down-days than up-days. You should avoid trading stocks during this phase.
Characteristics in this phase are things like: most days the stock price is below MA200, MA200 has also reversed to a downwards trend, the stock price is close to hitting "52 week low", the stock shows a series of "lower lows" and "lower highs", there are more down-days/weeks at high volume than up-days/weeks.
The image above shows an overview of the stock Netflix when it goes through the different phases.
Volatility Contraction Pattern (VCP)
You have now learned how to find stocks that are in phase two according to Minervini's principles. You also know in which phase you want to buy stocks and which phase you want to sell them. The next thing is to know exactly when to buy the stock, ie how to catch when it goes from phase one to phase two in the chart. Because it's not on the fundamentals you should buy, it's on technical "setups".
What you are looking for are proper bases or so-called VCP "setups". VCP stands for "Volatility Contraction Patterns", these patterns can often come after an already started phase two, where the stock needs a break/base to build strength for further upside. So how does this pattern work? It plays on supply and demand. The main role is that you should get a precise entrance point just before a break out through the consolidation pattern.
In the VCP pattern, volatility will go from "large" to smaller and smaller. You will also see a reduction in volume, ie less available shares for sale. This volatility fluctuation should have anywhere from 2 to 6 contractions. Here you will ideally have a contraction pattern equal to 25% oscillation from high to low -> 15% oscillation -> 8% oscillation, together with a reduction in volume for each oscillation. This will indicate that the base is complete. See the example below:
Ok, you have now found a stock approaching the end of a VCP pattern. It prepares to break out and start its phase two run, when do you buy? Here you're looking for something Minervini calls a "Pivot Point". A proper "pivot point" represents a complete stock consolidation, and is the point just before an acceleration. It is, the "last line of resistance". In other words, it is the point where the price becomes a trigger to enter the trade right at the breakout.
Here it may be a good idea to place an order to buy the stock if the price breaks above the "pivot point". In any case, you don't want to "chase" the stock if it shoots off to the upside without you getting in the trade. The reason why the share price will accelerate at high momentum when it breaks the «pivot point», is that there is little supply of shares after a dried-up volume during the VCP consolidation. Only a small amount of demand will send the stock price higher and out of a solid consolidation.
To get the best "pivot points" you want to see very low volume, often lower than the lowest volume that has been in the entire VCP consolidation just before the breakout. Preferably you will see a volume on the last contraction that is lower than the 50-day average volume on the VCP base. This event should preferably take place over perhaps two days. This does not always happen in stocks with a large market value, but it occurs more often in medium-sized and small stocks.
Either way, this is what happens just before the stock is ready for a big move. It is at this point that you should get ready to purchase the stock. You should buy at the breakout or when the price goes through the "pivot point". You would prefer to see that when the "pivot point" and the eruption from the VCP formation first occur, it happens with a higher than normal volume. It can quickly be 300/400% more than the average daily volume in the base. Do not try to enter until the stock breaks the base/ pivot. You only earn a few extra percent profit but take on a lot of extra risk. Wait until the stock shows the way with the break out of the formation/base/pivot point to the upside.
Win/loss ratio, position size, and risk management
Position size must be assessed based on how good your total average return is. If you were a safe 2:1 (gain/loss) trader, the optimal position size would have been 25%. This must be considered when you start trading. Start with small positions and gradually increase if you see that your winning percentage increases and the gains are greater than the losses (stop-losses).
Here Minervini refers to something he calls "batting average", ie what the average of your trades is in relation to loss/win. The lower the average of trades that goes in your favor, the greater the gain must be in relation to the losses. Let's take an example:
You have an average of 40% of all trades going in your favor (you should use a trading journal). Your optimal win/loss ratio is then 20% on the wins and 10% on the losses. Over 10 trades the ratio (ROI) will be 10.2 percent. If the average of trades that went in your favor increases to 50%, the return after 10 trades with the same win/loss ratio will be 80.04%. As you can see, these values can make a huge difference.
An average of trades in your favor over 50%, as well as a win/loss ratio equal to 2:1, is optimal and what you are aiming for. This gives traders following Minervini's principles optimal risk management. Of course, if you have secured some profits along the way in a trade and you have arranged a 2:1 ratio. Then you can let the remaining position continue, as long as the stock price follows the phase 2 criteria shown above.
If you are having a "bad" period, and you get an average of trades in your favor below 50%. Create TIGHTER stop-losses and reduce position size until you are back above this limit.
As you can see, the combination of Minervini's principles, as well as the execution of a correct entrance from a VCP pattern with a subsequent «pivot point», can give you an extremely good return. Learn how to uncover the different phases and know the characteristics of when you should enter and leave a trade. REMEMBER to always use stop-loss, a stock can always move against you. No matter how good the pattern or the fundamentals look. It is NEVER wrong to secure a winning position. Mastering Mark's strategy can be extremely valuable, and it can give you a very good return. Make sure that you understand and master the principles before entering a trade, and you may want to start with smaller positions in the beginning.
Good luck as a Minervini momentum trader
As mentioned, you will find links to his books for further study here:
Mark Minervini who is Mark Minervini part 2 what does Mark he is good Minervini part 2 Mark Minervini