How to find the next Nvidia!

My name is Chuck Whitman, and I build great traders that lead great lives. Traders I've trained have generated in excess of a billion dollars in trading revenue and are found at some of the largest proprietary trading firms and hedge funds in the United States. So how do we find the next Nvidia? Nvidia has been the hot stock in the last 15 months. It's rallied from a price of $28.35 to $130 a share, an increase of 358%. It's been the darling of the market. So everybody asks the question, How can I find the next Nvidia? Well, today I'm going to show you. 

To find the next Nvidia, we have to understand what are the characteristics of top performing stocks? We have to look at Nvidia and stocks like it to see what made them different than all the other stocks in the market. Once we examine these characteristics, then we can start to go find these names. So let's talk about these characteristics, characteristics of top performing stocks. One momentum stocks show the most consistent and profitable edge throughout the stock market's history, not value, not trend following, momentum. Two, the returns that drive overall stock market performance usually come from a small percentage of top performing stocks. Three, even though we're investing in momentum stocks, we must have some gage evaluation to make sure that we don't overpay for the stock. Four, trading top relative strength names will lead to outperformance and uptrends and trading bottom relative strength names will lead to outperformance and downtrends. Five, in five to ten minutes a day, you can manage your own portfolio and outperform the S&P 500 over a long period of time. Let's talk about these characteristics, and specifically, let's talk about the edge in momentum stocks. There's a lot of research that backs up this edge. Now, first of all, Andrew Carnegie and later Warren Buffett, they had this phrase that says, put all your eggs in one basket and then watch that basket closely. In our discussion today, what this means is that we can have a small basket of stocks that massively outperforms the market, and if we put them on right and we do our work the right way, they not only can have better performance, but they can be on less risk. 

So I want you to look at this map. This is a map to a gold mine. This is the attribution of collective return for a bull market and what I want you to look at, if you look through history and you look at the attribution of returns, look what you see, there's 8000 stocks that are analyzed in this analysis. Of the 8000 stocks, the top 2000 account for all of the gains. The top 2000 account for all the gains. The other 6000 stocks, and this is in a bull market, they have a return of 0, 0. So there's this belief that in a bull market, all stocks go up. It's not necessarily true. In some stages of a bull market. In a very healthy bull market, yes, most stocks go up, but as the bull market ages, more and more stocks fall off and at the end, there's just a handful of names. Think about the market up until recently, everybody was talking about the mag seven, the big seven stocks, the Google, Meta, Apple, Nvidia, Microsoft, Amazon. Those names are the big seven. They have continued to go up, while most of the market has gone nowhere for years, just look at the Russell 2000. AQR, which is one of the largest hedge funds in the world, they did research, they ran a study from 1926 through 2009 and let's look at some of the conclusions from the study. Stocks return 9.6% per year over that 83 year period. But if you had excluded the top 10% of performers, the return would only be 6.2%. This means that the top 10% was responsible for over 35% of the gains and just like the other chart we saw, if you excluded the top 25%, the return on the other 75% is actually slightly negative. In other words, the top 25% of performers accounted for more than 100% of the returns in the market. 

Another study done by Black Star Funds from 1983 to 2008 on the Russell 3000 showed it returned almost 10% a year. During this period, during this 25 year period, about 40% of the stocks had a negative return, and 20% of them basically went to zero, right? So 1/5 of all the Russell 3000 went to zero. 64% of the stocks underperformed the Russell 3000. So once again, clearly a number, a small number of stocks is responsible for most of the gains. In this case, 10% of stocks recorded huge wins, in excess of 500%. A small minority of stocks significantly outperformed their peers. 6.1% of the stocks dramatically outperformed the index, which is defined as five times the index or greater, and made up nearly 30% of the gains in the underlying index, while the top 20 to 25% made up all the gains in index, just like AQR and the other graph I showed you. All these studies draw the same conclusion, this edge in momentum stocks has been consistent over 92 years. A small percentage of stocks typically make up 30 to 50% of the gains in the indexes in any given year. You just got to find them. Okay, so how do we find them? Let's talk about some research. It was done by James O'Shaughnessy. James O'Shaughnessy, in his study, said there's an easy way to find these outperformers, it's called relative strength. Relative Strength is a core concept in everything that we do. We have different measures and gages of relative strength, but we look for it and we lean on it. In some of our classes, I show you how you can use relative strength in less than five minutes, you can take a universe of hundreds, maybe even 1000s, of stocks, and in less than five minutes, you can narrow it down to know which are the best names to go look at, that's what relative strength does. 

So O'Shaughnessy in his research, he found that momentum, stocks, momentum and relative strength based strategies were the most consistent and outperformance. They had, the most significant edge of anything he tested over the last 50 years. Later on, he focused on momentum value combinations, not just momentum and relative strength, but momentum combined with value, and he found that these were the most profitable strategies over the last 50 years, but they also had lower volatility and lower drawdowns. So relative strength and momentum worked on its own, but if we incorporated value, we not only got the same return, we did it with a lot less risk. His studies show that combining relative strength and Relative Value yielded stocks that sustained their gains better, the pullbacks were not nearly sharp. They went up and they stayed up. He found they had greater upside potential, they went further than the other stocks. He found out they held up better in periods of market weakness or corrections, as well as bear markets. So when the market corrected like it did recently in August, some of the best names they would hang in. Go look at a chart of GoDaddy. GoDaddy did not go down when the market was getting clobbered, and then when the market bottomed, GoDaddy exploded. Pure relative strength stocks tend to be only high beta, which means that they outperform in up markets, but they underperform during corrections and bear markets. Here's another study. This is courtesy of portfolio boss. If we just took the top three month and six month relative strength out of 600 stocks where you rotated each month with bonds and cash included to dilute drawdowns, so bonds or cash are top relative strength if the relative strength is negative. So note the out the consistent out performance from relative strength during bull and bear markets. Drawdowns had less than half of the index and returns were more than double since 1990. This methodology had been back tested all the way back to 1905 and found similar results in drawdown reduction and cyclical performance. So this is the performance of the benchmark index, and this is the performance of the top row of strength stocks, where we rotated. So you can see it clearly did much better, but also look at the drawdowns right here. They both went up, but then the index had a big drawdown, while the relative strength stocks went sideways, then they took off again and clearly this is outperforming on the way up this move, but then up here, stocks again, had a pretty indexes, had a pretty big correction, while the relative strength stocks had a minor correction, and they took off again. Clear out performance here. Cambria investment management, they did a testing of relative strength model on the French Fama US equity sector data back to the 1920s and what they found was relative strength portfolios outperform buy and hold by approximately 70% of all years, and the returns were persistent across time, which in buy and hold, that's not the case. Buy and hold is very volatile. 

One last bit of research, this is from Dorsey Wright in Man Versus Machine. Dorsey Wright basically looked at the real value of a qualitative investing model. He found that the margin of outperformance was larger in some decades than others, but while value and growth experienced decades of underperformance, momentum outperformed in every single decade. Momentum outperformed it every single decade. So you can see here we have French high momentum, French value, French growth, the S&P 500 and the sharp ratios. So if we look at high momentum, 2.3, 12.9, 23.3, essentially, if we look here from the 30s to the 2000s the high momentum returns were positive every decade. Value had periods where it was up and periods where it was down. French growth had up returns, but not as great and then the S&P of course, had up returns in negative returns in the 30s, but other decades of positive returns. But if we look at the cumulative, high momentum was 13%, clearly outperforming the others. If we look at the Sharpe ratio, which takes into account the volatility, momentum had a Sharpe Ratio point 0.55, clearly outperforming the other three strategies. So these are the edges. So if you want to go find the best Nvidia, you need to go look for momentum stocks and you need to go look for momentum stocks that have a valuation component. Now don't worry, we're not done. If you come back next week for Trader Tip Tuesday, we'll get into the details of how you find those names specifically, but for right now, I want you to make sure that you look below in the commentary, in the comments below, you're going to see a link. If you click on this link, it's going to give you access to a five day trial to our Reeds Trader Mechanical Report. Now the great thing about the Reeds Trader Mechanical Report is it will show you our top list of stocks which include momentum and value, so you can see that list for yourself. Not only that, we're also going to give you a link to a recording that you can watch on what we call the Slow Reeds Method. Now the Slow Reeds Method creates some of the biggest winning trades I have ever seen. These are stocks that you can buy, that you can make, 10, 20, 30, 50 times your risk. Everybody dreams about these, but slow reads actually shows you how to find them. So there's a link here to a webinar that you can click on and you can watch to gain some insights as to what slow reads is all about. 

So what day is it? Yeah, it's Tuesday. It's not just Tuesday. It's Trader Tip Tuesday, where every Tuesday I come to you with tips and insights, like today on the edge and momentum stocks, that helps you take your performance to an elite level. I'll see you next Tuesday.