Indicator of the Week: The 20 Best-Looking Charts of 2016

For many traders, a stock's price chart is one of the main determinants when deciding whether or not to buy a stock (or an option on a stock). Many times when looking for stocks to trade, I want one in a steady uptrend. However, there are thousands of stocks and I can't look at every single chart, so I came up with a method for ranking an equity's price chart. This week, I'm going to explain the method, quantify how the stocks have done, and show a list of stocks with the best charts so far in 2016.

What Makes a Beautiful Chart?: Beauty is in the eye of the beholder when it comes to price charts, and different trading methods call for different-looking charts (e.g., some might look for sharp pullbacks, double-bottoms, etc.). But here, I'm looking for stocks that are in a steady upward climb with very few periods of losses.   

My method for ranking charts combines four pieces of information about a stock's price. I used the number of up days the stock had, the standard deviation of the daily returns, the maximum drawdown of the stock, and the overall return. It's probably obvious, but below is how those four data points affect the ranking:

• The more up days a stock had, the better the ranking.
• The lower the standard deviation of returns, the better the ranking.
• The smaller the maximum drawdown of the stock, the better the ranking.
• The higher the overall return on the stock, the better the ranking.

I consider standard deviation of returns because I'm looking for charts displaying a very methodical climb higher. The maximum drawdown for a stock is the most you could have possibly lost on the stock, had you bought it at a high and sold it at a subsequent low. Combining those four data points, I came up with a single number between zero and 100 to rank the stocks.

Pretty 2016 Charts: Using this chart scoring method, I found the best-looking charts among S&P 500 Index (SPX) stocks. I narrowed down the list by focusing on stocks meeting specific option liquidity criteria (since we specialize in options trading here at Schaeffer's Investment Research). Below are the best-looking 20 charts among these stocks. Looking at a year-to-date price chart should closely resemble a straight line, at a 45-degree angle, from the lower left of the chart to the upper-right corner.

Predictive Power?: Okay, so we know which stocks look the best, but we also know that history does not necessarily tell us about the future ... or does it? Looking at SPX stocks and using the same methodology as above, I ranked the stocks based on their price action in the second half of 2015. Next, I summarized the returns so far in 2016 of the best 50 chart scores, and compared those to the worst 50 and all others.

The table below shows the stocks with the best charts in late 2015 have performed outstanding compared to other stocks so far in 2016. The 50 best equities have averaged a gain of 7.91%, with 86% of them being positive. These numbers are head and shoulders above the other stock groups. I know what you're going to say: "But the 5% average return of the worst charts is a pretty good return through about six months."  Yes, it is -- but look at the median returns for that group of stocks. It lags the other groups, indicating the average return is being buoyed by one or two outlier returns. Also, of the worst charts, just 54% of the stocks are positive so far this year. Finally, the standard deviation of returns is through the roof under the "worst charts" column, implying a lot of risk in these stocks.  

This is only looking at one six-month period. So, what does another period look like? The table below is the same type of analysis as above, except the stocks are ranked by their price action in the first half of 2015, and then the returns are summarized for the second half of 2015.

Wow! The outperformance is even more pronounced in this time period. The S&P 500 was down a little bit over this period, but the best-looking charts in the first half of 2015 averaged a gain of 1.92% over the second half of the year, with 60% of the returns positive. The mid-tier stocks averaged a loss of 2.71%, with only 42% positive, and then the worst-looking charts averaged a loss of over 16%, with only 16% of the stocks positive.

Let's go back another six months and do the same analysis. We'll rank the charts by their price action in the second half of 2014, and summarize their returns through the first six months of 2015. In this time period the best charts do not outperform the other groups. The SPX was pretty flat over this time frame, but stocks from the best-looking charts averaged a loss of over 1.5%, and less than half of them were positive. The worst charts performed poorly, as well. As we know, there isn't a fool-proof method for finding winning stock picks, but over the past several months, this one has been a pretty good strategy.

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