In this article, we'll explore the method that not only allowed Mark Minervini, with the SEPA strategy, to outperform the market but also gave him a remarkable 33,554% return during the period from 1994 to 2000, and 334% in 2021.
Interestingly, after deciding to sell his positions in 2021, he hasn't re-entered the market, except for some small trading with small amounts of capital. But, why did he make that choice?
Let's explore the answer to this question from a global perspective and then zoom in on a specific approach, enabling you to invest like a market wizard.
Let me introduce you to the SEPA method (Specific Entry Point Analysis).
What's this all about? It's the concept of increasing your investment when the asset's value is rising and reducing it when it's declining. It's important to remember that having a strategy is crucial, so you don't get swept away by market fluctuations.
1. Macroeconomics: don't fight the FED
On November 22, 2021, Minervini posted on his Twitter account that it was the perfect time to take profits and exit the market. This statement came just two days after his winning trades. Although I couldn't find the exact tweet, I'd like to share one he wrote a few days later.
Isn't it quite a coincidence that this decision coincided with the market showing its first signs of weakness?
Simply put, the Federal Reserve (FED) made a significant shift in its stance. They changed from considering inflation as temporary to pledging to take all necessary measures to bring inflation back down to 2%. They took substantial actions, leading to the fastest interest rate hike in history. This resulted in an 18% drop in the S&P 500 and more than a 30% decline in the Nasdaq.
Hence, this brings us to Minervini's first rule: Follow the lead of the Federal Reserve.
It's worth noting that Minervini achieved impressive returns during two distinct financial bubbles:
- The first one was during the period from 1994 to 2000, which coincided with the dot-com bubble, a time when interest rates were at their lowest.
- The second was during the period from 2020 to 2021, which aligned with the tech bubble encompassing cryptocurrencies, the metaverse, and Web3. Again, this happened when interest rates were exceptionally low.
However, it's essential to understand that the key is not just investing when rates are low but doing so when the Federal Reserve aims to stimulate economic growth.
Now, you can see why, since November 2021, Minervini has viewed the market as entertainment rather than a valuable investment opportunity.
2. Fundamentals: CAN SLIM
Now that we know when to enter the market, let's focus on which companies to consider.
I won't delve into this point too deeply because, in this regard, Mark Minervini closely adheres to the CAN SLIM methodology developed by William O'Neil, who sadly passed away on May 28, 2023.
Here's what to look for when selecting companies:
- Earnings per share growth of at least 25% from the same quarter last year to the current quarter.
- Consistent corporate profit growth over the last 3-5 years, also at a minimum of 25%.
- Characteristics of leading or challenging companies.
- Institutional favorability (the “I” in CAN SLIM).
- Presence of disruptive products (the “N” in CAN SLIM).
- Minimum annual sales growth of 10%.
- Avoidance of pitfalls like stock splits or excessive share issuance.
In summary, unlike value investors who prioritise low P/E ratios, Minervini, as a growth investor, seeks out companies with high P/E ratios, with the expectation that these ratios will continue to rise. However, like any prudent investor, he emphasizes the importance of fundamental analysis but won't invest in a company unless its technical indicators also align.
3. Technicals: Volatility Contraction Pattern (VCP)
Now that we know when to start investing and which companies to consider, the next question is whether these companies have the momentum to justify an entry.
To answer this question, we turn to the well-known Volatility Contraction Pattern (VCP), a strategy that Mark Minervini strictly adheres to (assuming the previous criteria have been met).
Like O'Neill, Minervini places importance on the Relative Strength Index (RSI) and how to use it. However, Minervini doesn't demand as much as the late investor. For Minervini, as a growth investor, it suffices for the RSI to be in overbought territory (above 70). But the following chart pattern must also occur:
Chart patterns and volume
- Chart Patterns: If you observe, there's a compression of prices from left to right, resulting in decreasing volatility, forming what's known in chart analysis as a wedge.
- Volume: Meanwhile, as the price compresses, trading volume decreases, creating a kind of bearish divergence with the price. This may seem curious, doesn't it?
So, what's happening here?
According to this market wizard, what's occurring is that retail investors (individual investors like you and me), reacting to positive news linked to fundamentals, want to buy shares. This reaction is logical, considering the company's financials are strong, right?
However, they consistently encounter resistance from institutional investors, who sell and push down the retail investors. This push and pull happens repeatedly, forming waves. Gradually, as retail investors become frustrated, they start to withdraw from the investment, leading to reduced volatility. As they push less and less upwards, institutional investors also exert less downward pressure.
At this point, when retail investors have exhausted their efforts and trading volume is lower than usual, with a few well-timed orders driven by institutional capital, significant price movements can occur.
Now, with retail investors on the sidelines (some may even have taken short positions, anticipating further declines), it's time to place a long order in the market.
At this juncture, with low trading volume and substantial orders executed by institutional investors, the price breaks out of the wedge pattern to begin an upward trend.
Let's see in the chart, everything explained:
- Black lines: These show the wedge pattern.
- Purple lines: Price-volume divergence occurs.
- Navy blue circle: Entry point.
- Orange line (barely visible): Stop-loss, slightly below the wedge.
Of course, I understand that you're a discerning reader, and there are several additional details to clarify, including:
- The requirement for the stock's price to be above its 150 and 200-day moving averages.
- The condition that the price should be at least 30% above its 52-week low.
- The importance of risk management, emphasising that making ten 10% profitable trades is more advantageous than aiming for a single 100% gain.
- Using daily Japanese candlestick charts.
Examples of growth stocks
Finally, as usual, I'll provide you with some examples of growth stocks. However, please note that these stocks are not purchase recommendations, nor does it imply that they are currently following Minervini's SEPA strategy.
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Summary SEPA strategy
In conclusion, we've delved into the core principles of Mark Minervini's investment strategy, offering a condensed yet comprehensive overview of his approach to the stock market. By emphasising key factors such as timing, company selection, and the Volatility Contraction Pattern (VCP), Minervini's strategy provides a roadmap for aspiring investors seeking to achieve significant returns.
How does SEPA differ from other trading strategies?
SEPA differs from other strategies by emphasising the importance of timing. It combines fundamental analysis, technical indicators, and chart patterns to identify optimal entry points. It's known for its attention to detail in selecting stocks with strong growth potential.
Is SEPA suitable for all types of investors?
SEPA is primarily geared toward growth-oriented investors. It may not be suitable for long-term investors or those seeking income from dividends, as it focuses on capital appreciation.
Can SEPA be automated or is it a manual strategy?
SEPA relies on a combination of fundamental analysis and technical indicators, which can be incorporated into both manual and automated trading strategies. Some traders may choose to implement SEPA manually by analysing stocks individually, while others may use automated systems to identify potential candidates based on SEPA criteria.