Using Stock Screens Like Wall Street's Savviest Traders

Using a screening tool is one of the most reliable ways to find higher probability trading opportunities in the markets. Whether you use free stock screenersora paid service, there are a wide variety of different screening metrics that can be used to find opportunities. This is true for both short-term and longer-term strategies. Below, we offer some examples of the type of screens that can be used to improve trading opportunities. These metrics can be used effectively both on an independent basis and when they are combined with one another in a more detailed screen. 

Moving Averages- Screening for stocks that are approaching key moving averages can be an effective way to find opportunities because so many market participants use them. As a result, volatility and volume are often elevated around these key levels. There are a myriad of different ways to use moving averages. 

Some traders like to buy stocks as a shorter-term moving average moves above a longer-term one. For example, a screen could be run looking for stocks where the 20-day moving average is rising above the 50-day. This is a sign that price action is gaining momentum to the upside. Conversely, a sign of a possible breakdown would be if the shorter-term moving average is moving below the longer-term one. 

Another way to use this metric is to screen for stocks that are trading above or below a series of moving averages, such as the 200-day, 50-day and 20-day. This is a reliable way of identifying either strong or weak stocks. Some traders also like to use moving averages as either support or resistance levels. For example, they would buy a stock as it pulls back to its 200-day moving average, or short a stock as it rises and approaches this level. 

Unusual Volume- One of the most important factors when identifying high probability tradingopportunities that novice traders often overlook is volume. Think of volume as the fuel that drives stock prices. When volume is unusually heavy in a particular stock it may be a sign that supply and demand dynamics are skewed to one side -- and this is what traders need in order to make money. 

The easiest way to find stocks that are attracting unusually heavy volume is to run a scan across a universe of stocks. The timeframe could be anything from a day to a month or more, depending on strategy. For example, if a stock's volume has been steadily rising for the last two weeks and it has recently broken out of a trading range, this could be a good indicator that an even larger move is setting up as more and more market participants get involved in the name. 

Unusual volume scans can be particularly effective when combined with other methods such as technical analysis. An example of this would be to scan for stocks that have made very large moves either up or down in a short amount of time. Traders could then put these names on a watch list and wait for an indication that momentum and volume are starting to weaken in the stock. 

When this happens, it can often be a good time to fade the initial move and bet that price action will reverse. In fact, most technical analysis strategies such as trend following, reversion to the mean, breakouts, double tops and bottoms, and head and shoulders formations can be optimized by combing them with volume patterns. 

Volatility- Running a scan looking for unusual volatility is a simple and effective method of quickly finding opportunities. Short term traders thrive on volatility because it amplifies potential profits. This is because the amount of potential reward is greater as a function of the risk taken in these situations. 

For example, if a trader were to take a position in a $100 stock with a stop-loss of $1 per share he is risking 1% of his capital outlay on the trade. In this case the risk is fixed and the potential reward will be a function of the volatility in the stock. If the stock moves 2% in his direction during the life of the trade, his profit will be double his 1% risk. If, however, the stock moves 7% during the life of the trade, he will make seven times the amount he risked. 

Of course, this is a simple example, and elevated volatility can also increase the chances of getting stopped out in a particular trade. Generally speaking, however, successful traders seek out volatility because it can enhance the risk/reward profile as noted above. 

Relative Strength (RSI) - This is a measure of where a stock is versus where it has previously been. The RSI reading is a number between 1 and 100 which indicates the relative strength of a stock. A high number means that a stock has been strong and a low number indicates that it has been weak over a designated timeframe. Scanning for stocks using RSI allows traders to quickly find unusually strong or weak stocks. Again, RSI can be incorporated into a more robust scan using additional metrics such as moving averages, unusual volume, and volatility, among others. 

RSI can be utilized effectively to either trade with the trend (i.e., buying strong stocks and shorting weak stocks) or it can be used to try to identify turning points. For the latter strategy, a trader might scan for stocks with an extremely high RSI, such as above 80, on the expectation that these names may be especially susceptible to a sharp reversal. 

Short Interest- Screening for stocks that have unusually high short interest is a great way to find trading opportunities in specific names. One of the best ways to use this metric is to identify short squeezes. When traders short sell a stock in expectation of a price decline, they eventually have to buy it back in order to replace the shares they originally borrowed to execute the trade. 

When good news is released about a stock that has been heavily shorted, the ensuing move can often be extremely powerful -- more so than if the stock had a low short interest. This is because there are two groups of aggressive buyers in this scenario. First, there are investors and traders who accumulating the stock because of the positive development. 

Secondly, there are short sellers who are buying back the stock that they previously sold short in order to cut their losses or preserve whatever profits they may have generated. Often times, this can lead to a frenzy of buying and huge short-term moves in prices. 

Short interest screens can also be an effective way of identifying trend trading opportunities. For example, a trader could run a scan of stocks that have broken through a key moving average to the downside and also have high short interests. This information suggests that savvy traders are betting on price declines, which could accelerate as support is broken. In this scenario, a trader could enter a short position as price moves through the moving average to the downside.