3. Locate favorable average velocity for great stock candidates

Sand Storm! 2010: Act I, Scene 3; The Average Velocity Depends on Location.

By this we mean that we can build a regular grid of measurement cells throughout this normal space, each cell uniformly spaced in qReturn and pRisk coordinates. We can find the stocks with their qReturn and pRisk coordinates inside each grid cell, and add up their individual velocities. Dividing by the number of such stocks, we get the arithmetic mean velocity at that grid cell. This is the same calculation we did to get the global average velocity arrow in the upper left corner of the chart, using all the stocks in the chart. Since that global average says that the entire mass of stocks is headed in that direction with that speed, you might expect the local averages at each grid cell to look very much like the global average. To bring out the location dependence, we subtract the global average from the local grid cell averages, to show a chart of local velocities with respect to the global flow. If this were a tidal current chart, we might put up a global average arrow to let you know which way the tide was taking you, and then show the relative local velocities so you could see any whirlpools spinning along with the stream.

This notion of local average stock velocity is another very important feature of the DiligentInvestor econometric model, because of the surprising discovery that these average velocities appear to be spatially coherent. That is, neighboring cells have similar velocities. Typically, increasing returns appear at the top of the chart, decreasing returns appear at the bottom, and the higher speeds occur on the right. The Sand Storm! 2010 Blu-ray animation shows you the changes in this pattern of velocities, so you see likely locations for great stocks, where the velocity is relatively more toward higher return, and at a relatively greater rate of increase. The Velocity Snapshot taken from the animation illustrates a frame from Scene 3 as a grid of local velocity arrows. Like the global average velocity in the upper left corner, the local average arrows are blue when the average stock return is increasing, orange when decreasing. The animation shows the effect of a rapidly moving stock, changing the local velocity at successive locations as the stock ripples through their grid cells. Scene 3 corresponds to the current and historical change charts mentioned in the Distribution section of the Scatterplot Chart and which appear in the Gallery. Just as in those still images, the straight blue line attempts to separate the blue arrows from the orange arrows, and the purple curve marks the peak of the dune, or maximum density in successive horizontal slices. Here density means the number of stocks within the area of one grid cell or square.

Not all grid cells are shown, since some locations near the edges of the chart seldom have any stocks in them; no data, no arrow. At some grid cells, the local velocity arrow is too small to show. This is especially true near the center of the chart where most stocks are located. There the average velocity is the about the same as the global average, so the local difference is small. To the investor, this indicates areas where there is little opportunity to find unusual stocks with favorable characteristics. On the other hand, notice the larger blue arrow on the high risk side of the chart, right on the upper standard deviation line for risk, surrounded by a flock of orange arrows. This favorable average velocity location includes the winner stock mentioned on the previous page, return going up and its Friday closing price above its normal envelope of behavior. This suggests that this stock is worth further investigation.

© Copyright 2010 DiligentInvestor