Meet the relatives: Charles Kirkpatrick’s strategy for finding cheap growth on the move

Over the past 50 years, Charles Kirkpatrick has earned a reputation for being one of the most respected names in trading. Yet for a long time, his ideas were completely at odds with the theory that stock markets are efficient. It was only through dogged determination that he showed how emotions like fear and greed influence markets - and how they can be exploited by savvy investors.

Kirkpatrick’s path to prominence began in the late 1960s when he worked with an academic called Robert Levy. Their research showed how relative price strength could be used successfully to pick shares.

But Levy’s findings didn’t go down well with everyone. He was ridiculed by efficient market theorists who rejected the idea that markets could be irrational. Kirkpatrick didn’t relent. He stuck with Levy’s ideas and in 1982 started tracking them in real time on a weekly basis. A full 17½ years later, he wrote about the experience in an award-winning paper that laid out how brilliantly a strategy based on price momentum had performed.

Kirkpatrick’s career as a prolific writer and educator led to numerous books spanning technical and fundamental analysis through to human and market behaviour. Ten years ago he published Beat the Market: Invest by Knowing What Stocks to Buy and What Stocks to Sell, and dedicated it to “Robert Levy, a relative pioneer”.

Here are some of the main points that Kirkpatrick makes in his book:

#1. Be a DIY investor

“You have to make investment decisions for yourself because the investment management business makes more money from you than you do on your investments with them.”

#2. Watch out for emotions and biases

“Whether it’s stupidity, gullibility, naivete or inattention to the peculiarities of human interaction, common sense often falls victim to popularity and hype.”

#3. Volatility isn’t risk (it can be desirable)

“As a practical investor desiring to profit from a rising trend, you need to be aware that risk is best equated with the possibility of capital loss and not simply with volatility.”

#4. Don’t try to guess the future

“Most professionals with considerably more timely and accurate information than you cannot predict the markets. You don’t stand a chance.”

#5. Reaction is better than prediction

“Reaction takes place in three steps: the setup, the trigger and the action (STRACT). It takes patience to wait for the setup and speed to act when the trigger ‘snaps’.”

#6. Meet the relatives

“The three principal methods for selecting stocks are Value, Growth and Price Strength... The method I use looks for ‘relative’ data. Relative data... gives a better picture of how a stock is performing technically and fundamentally against all other stocks.”

The final point - Meet the relatives - is an important part of the book. Kirkpatrick suggested the use of ‘relative’ measures of value, growth and price momentum, rather than ‘absolute’ measures. Then he then presented ways of using them in three strategies: a Growth model, a Value model and a Bargain list.

The rules were simple. For instance, the Growth model simply looked for shares with the highest relative price strength, the highest relative earnings growth and a positive price trend.

A Stockopedia screen that models Kirkpatrick’s growth rules for the UK market looks for:

• The top 20% of shares with the strongest share price vs 130-day Moving Average
• The top 10% of shares with the strongest growth in operating profit

This strategy (pre-costs) has seen an 85% return over the past five years, with a big chunk of that achieved in 2016 and 2017. The last 12 months have seen another pick up in performance, with a one-year return of 17.7%.

Here are some of the shares currently passing the rules. They’ve got a distinctly small-cap flavour (and Kirkpatrick did actually prefer mid- and large-caps), but they are squarely in the high quality, high momentum area of the market:

Ideas from a market master

Charles Kirkpatrick’s contribution to market thinking has been immense over the years and he remains highly respected for his work in technical analysis. His ideas around behavioural finance and the emotional drivers of price trends were controversial when they first aired, but are now widely accepted.

Likewise, his insights into ‘relative’ measures of growth, value and price momentum have become important components of many other stock market strategies. His guidance offers some important reminders about the occasional madness of markets and how savvy investors can profit from them. As he explained:

“As long as the human race can become excited or morose, affected by greed and fear, stocks will travel under and above their true value in trends, and make the relatives useful.”