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Hedge funds and high frequency traders seem to be getting all the action these days. The market pops up one week and slams down the next with extreme volatility as full-time traders armed with their computer algorithms make record profits. In fact, one U.K. trader lies awake at night dreaming about recessions or volatile markets such as the one we have today.

Does this mean that the average retail trader merely sits by waiting for calmer markets to return? Not at all. While I use a combination of index timing techniques with various dividend strategies for a long-term market-beating result, the focus of this article is on a short-term trading strategy that is rooted in fundamental analysis. As the saying goes, if you can’t beat them – join them.

Short-Term Trading Strategy

This is not some technical analysis strategy that has you trading both sides of the fence – both long and short. This is a short-term aggressive bull strategy that will rise very quickly on up-weeks - but it will also give back gains during crashes. No market timing is required as you want to be invested at the earliest possible entry.

This strategy utilizes the Post-Earnings-Announcement-Drift phenomenon (PEAD). We also incorporate the technique of buying stocks with recent upgraded earnings for the next fiscal year. As well, stocks which have underperformed the market over the past year are removed. This is a concept we borrow from momentum investors. Finally, we only invest in stocks that do not have options. It is my belief that hedge funds and related traders migrate towards stocks that they can easily leverage. We will let them have their stocks if we can have ours with less manipulation.

What of our selling rules? We only stay invested a maximum of 12 trading days. This is our key selling rule. We also sell if quarterly earnings are reported without a large surprise, if the stock begins to significantly underperform the market, or if earnings forecasts don’t stay strong. The most important aspect is our 12 day trading rule, although you can adjust this anywhere you want between 10 and 15 days (2 or 3 trading weeks).

Short-term Trading Performance

How has this strategy performed over the past 5 years? Starting with $25,000 of capital 60 months ago you would have 7.3x that much today.

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Keep in mind that this does not include trading fees and slippage. If you have high transaction fees and use abnormal sums of money per trade thus creating large slippage, expect the profitability to drop dramatically. If you only use smaller sums to slip in and out of stocks easily and have a low cost broker, this should be a well-performing strategy, although it still struggles in down markets such as the ones we have been in since late July. If you add in a market timing element, you can lower your maximum portfolio loss up to half, but your overall gain remains similar since you are not capturing the lowest point of a market bottom.

Historical Picks

What sort of stocks has this picked up in the past year?

  • Mercer International (MERC) met all the criteria on January 24th at $8.06. 12 trading days later it was sold for $10.67. Prices continued strong up to $14.40 over the five trading days.

  • Titan International Inc. (TWI) hit the radar on April 18th at a $25.26 price. It was sold 12 days later for $30.48.

  • Nature’s Sunshine Products (NATR) was screened as a buy on June 20th as prices opened at $14.86. It was recommended as a sell on July 5th for a price of $19.64.

  • A recent profitable recommendation came from Points International Ltd. (PCOM). The buy signal was given on September 12th at $8.17 per share and the 12 trading day sell signal on September 29th with $10.20 share prices.

Recent Recommendations

  1. Kona Grill Inc. (KONA) – This recommendation came up on September 26th at $5.99. After the 12 trading days it re-met all the requirements to be held for another 12 days as of October 14th with the second entry being $6.38. Prices are slightly down since then and October 25th is the earnings announcement. I typically do not like to hold the day of the announcement and would be a buyer after earnings, provided we have another 50% surprise. A 7.5 cents or higher on reported earnings would be the target to buy back in.

  2. Hurco Companies, Inc. (HURC) – The buying alarm bells are going off as prices are at $25 per share. According to the short-term trading strategy, a small position with a 10 – 15 day holding period would be prudent.

  3. CVD Equipment Corp. (CVV) – CVD Equipment designs solar, nano, high-purity gas, and electronic assembly solutions. As prices are hovering just above $16, this small pull-back gives a good entry for a small short-term position.

  4. Callidus Software (CALD) – An earnings announcement is expected October 27th. Again, I find it best not to hold directly before earnings. The expectation is zilch, so any earnings – even 1 cent – would put this stock into our buying zone.

  5. Safeguard Scientific, Inc (SFE) – Earnings are released on October 26th. Recently the analysts have slashed estimates down to 17 cents. Therefore, if reported earnings are 26 cents or higher, it would fit our short-term trading criteria.

  6. Encore Bancshares, Inc. (EBTX) – I’m not big on financial stocks in this market. If you are one that does –you have a short window of opportunity before earnings come out on October 28th. If you wait until after earnings, you’d need 20 cents or more before triggering a buy.

  7. Education Realty Trust, Inc. (EDR) – I’m also not big into REITs with this strategy, but one did come up with EDR. October 27th is earnings, leaving a small trading window before reported earnings. If you want to buy after the earnings are announced, we would need to see 5 cents or more with some upward revisions for the 2012 forecast. I’m not holding my breath.

Being an Aggressive Short-Term Bull

Short-term trading can be a good strategy in volatile markets as opposed to long-term portfolios which often rise and fall with little net gain. This short-term strategy is an aggressive technique that attempts to take short-rides on rising stars. Many trades will not work out but that ones that do will often be stellar.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: 7 Aggressive Short-Term Trades For High Potential Gain