Selecting or ranking short-term momentum stocks can be a challenging task. A work that could serve as a reference is available at http://short-term-stocktrading.com/finding-hot-stocks/.
I like to get into positions when they are moving and then get out in two or three days. And if you are going in and out in 2 to three days you need stocks that are really moving. This is a highly effective way to trade and combines safety with very high yields.
This encapsulates the essence of my approach to short-term momentum trading. The key is to identify stocks that are experiencing rapid movement, hold them for 2-3 days, capitalize on the upward surge, and then swiftly move on to the next opportunity.
Identifying hot stocks can be a little tricky. At one time I used a simple form of back testing to do this. I would grab a market, get a couple months of tick data for that market and then apply our trading system and look at the results. If the results looked good I would put the market into my portfolio and if the results looked bad I would discard the market.
The results of this method could be disappointing. A market that had made good money for 8 weeks might produce a string of two or three losing trades just as I was putting real money on it and the market that I had discarded might start making money.
What I soon realized was that this approach was really a form of optimization that was in effect trying to predict future trading system performance by trying to fit a system to a given set of data. It was a form of curve fitting and curve fitting is the worst thing you can do to identify profitable trading. This simply was not a good approach.
Backtesting is not a good way to select stocks with strong momentum.
The markets that worked best with our trading methodology, the true hot stocks, were markets that had repeated expanding, volatile break outs with follow through for a day or two. After an expansion of range the market might contract for a few days but this contraction might then be followed by another expansion and then some more follow through.
Repeatedly breaking out of consolidation patterns and exhibiting follow-through is the type of stock that aligns well with our trading strategy.