102-31 Investing Strategies

In this section of the training course, we take a look at the different types of strategies utilized to try to make money in the stock market.  You should try to adopt the type of trading strategy that suits your style of trading.  Each style has its own unique advantages and disadvantages, which we will discuss.

Buy and hold

The oldest strategy known to man, the buy and hold strategy is simple.  You buy a stock, and you hold it for a very long time.  The idea here is that the stock market over long periods of time increases in value.  We have already seen that the U.S. markets have made an average return of between 5% and 6.5% per year since inception.  So the theory of buy and hold is that is you own a stock long enough eventually you will come out with a profit.

Is Buy and Hold Investing Still Cool? 3 Methods + 5 Key Advantages

Advantages

If you select the rights stocks, this strategy can pay off over time.

Works best if you buy an Exchange Traded Fund (ETF) that tracks the market

Less trading costs, and you buy and sell infrequently.

Disadvantages

The problem is selecting the right stocks.  All stocks reach new highs, but also fall out of favor with the market and can spend a long time at multi-year lows.

If you buy the stock at the wrong time and hold on to it even though it moves down a lot, then you may be in a situation for many years where your capital is in a stock that is not appreciating in value.  You will be suffering from lost opportunity and therefore underperforming the market.

Average trade duration

Long term – years

The effort to maintain the strategy

Low – as you very rarely buy or sell a stock, it requires little maintenance.

Risk Rating

Medium

Value Investing

Value investing is a strategy that entails seeking out companies that have a very low valuation in the stock market, but actually have a lot of intrinsic value.  The intrinsic value essentially means the actual worth of the company, its assets, cash, market position, income, and goodwill.   It can be difficult to calculate intrinsic value; this is what makes value investing a time-consuming strategy.

The most famous value investors of all time include the father of value investing Benjamin Graham and Warren Buffett.  Buffett is widely considered the greatest investor of all time.

Value Investing Strategy: 7 Proven Ways to Find Value Stocks

Value investors believe that the stock market constantly undervalues companies, and therefore this undervaluation represents an opportunity.  The more undervalued the company is, the higher the margin of safety.  The margin of safety is the difference in the market capitalization of the stock and its actual intrinsic value.

Further Reading: The Intelligent Investor. Benjamin Graham.

Advantages

Value investing is a well-proven strategy that is clearly evident in the success of Warren Buffet and the Berkshire Hathaway Group.

Disadvantages

If you cannot decipher company accounts and devote the time to researching companies in detail, you will not be successful.

You may find a good company but its share price may not move for years.

Average trade duration

Long Term – Years

The effort to maintain the strategy

High – lots of research required

Risk Rating

Low to medium

Diversification

If you are to pursue a buy and hold strategy as previously mentioned is may be beneficial to ensure that your portfolio is adequately diversified.  To diversify, you would likely want to use a mixture of the following investment vehicles.

  • Bonds
  • Treasuries
  • Stocks
  • ETF / Mutual Funds
  • Real Estate
  • Currencies

You could, for example, choose 4 of the above options and split your portfolio among them 25% each.  Or, depending on your risk profile and your stage of life, you may want to go for the less risky bonds at 50% of your portfolio and use only 10% of your portfolio on stocks.

Modern Automated Portfolio Management Services Can Provide This

Advantages

Diversification can reduce the downside of any particular crisis.  If there is a recession, the bonds are a safe bet.  But if the economy hits a boom, then the best returns are from stocks.  With diversification, you can seek to hedge the downside whilst experiencing some of the upsides.

Disadvantages

If you diversify into investment vehicles, you do not understand you may suffer.

Too much diversification may mean your portfolio is hard to keep track of.

Average trade duration

Various – depends on the investment choice.

The effort to maintain the strategy

Medium to high – more diversification means more work

Risk Rating

Low / Medium – even the best-diversified portfolios can lose money

Sector Rotation

The investing strategy of sector rotation is based on the principle that during different periods in the economic cycle, different sectors will benefit the most.  This is mostly practiced by the large fund and portfolio managers in order for them to try to outperform the market.

The economic cycle can be split into four stages:

Early Recovery

This occurs after a recession.  During the early stages of recovery from a recession, you may see that transportation companies are seeing more profits, and they are starting to move around more products to market.  Auto manufacturers who have been crushed to near bankruptcy are recovering.  The industrial sector starts to pick up.  As growth starts to emerge from the ruins, good sectors to potentially invest in are recruitment, recovering industrial conglomerates that have avoided bankruptcy and technology.

Late Recovery (Boom Time)

During this period, the world is a great place for stocks, the consumer is in buying mode, and consumer durables and technology are doing well.  Retailers (online and offline) are seeing huge demand and lending is increasing.

Early Recession

Growth is starting to slow down, and the pace of expansion cannot continue.  The move to more secure investment categories starts to happen.  Bonds come back into favor, and the business sectors that may see improved performance are utilities (water, gas, electricity) and certain cyclical industries.

Full Recession (Bust)

In a full recession, the economy is bad, unemployment is higher, and interest rates are being reduced to stimulate growth.  During the bust, it is best to not be in stocks.  But if you feel you must, good sectors are those that provide the goods people cannot live without such as food, heating, energy, health.

Advantages

It can provide some shielding against the economic ups and downs.

Disadvantages

You really need to understand economics and have a good grasp of where the economy is in the business cycle.

Even if you practice sector rotation is does not mean it will be successful or that you will select the best company or vehicles to invest in.

Average trade duration

1-2 years per rotation

The effort to maintain the strategy

High – constantly evaluation the economic situation and having a good grasp of all tools and companies can be time-consuming.

Risk Rating

Medium

Day Trading

Day traders are a special breed.  Specializing in many short duration trades, they operate using technical analysis to seek many small wins in the minor fluctuations in stock prices.  Technical analysis is the use of charts based on stock price and the volume of shares sold for the day.

Due to the fact, the day traders make many trades in a day, many of them seek to use leverage in the trades.  For example, they may borrow $50,000 from their brokerage firm and have only $10,000 of their own capital.  This is a 5 to 1 leverage.  This means they can multiply their gains or make more trades in a day.  Seeking a small gain from the intraday fluctuations in a stock price is also called scalping.

Advantages

If you are exceptional and have developed your own specific edge in the market place, you can potentially earn more returns than the average returns of the market.

Disadvantages

This is an incredibly risky trading strategy.  The vast majority of day traders (up to 80%) lose most of all of their investment capital within the first year they start trading.

This is a very stressful way to make money and also very time consuming as you are watching the stock charts in real-time the whole day, every day.

High transaction costs – making so many trades means you have to pay for each transaction, this means you need to make more money per trade to cover the costs of the trade.

Average trade duration

Minutes to hours

The effort to maintain the strategy

High – lots of hours and every day

Risk Rating

Very high – use of leverage and trying to predict the essentially random tick by tick fluctuations in stock price movement is highly risky.

The Best Trading Platforms for Day Traders

Swing Trading

Swing trading focuses on trying to make a profit from stocks that are about to make a short term change of direction.  Swing trading is short term but not on the scale of day traders, typically 1 to 5 days.

Swing traders focus purely on the technical situation of a stock.  They are interested only in the stock chart and the momentum (rate of change in the stock price).  There is no real interest in the company’s fundamentals or economics in general.

Advantages

With a mastery of technical analysis, this can be a good way of taking advantage of price movement in stocks.

Staying primarily in cash and staying in trades for shorter periods can reduce the risk of loss during correction days in the market.

Disadvantages

Trading in and out of stocks too frequently can mean that you miss out on any major medium to long term gains in stocks or in the market.

If your timing is bad, you can lose a substantial amount in a short period of time.

High transaction costs – making so many trades means you have to pay for each transaction, this means you need to make more money per trade to cover the costs of the trade.

Average trade duration

1 to 5 days

The effort to maintain the strategy

High – many trades

Risk Rating

High

CANSLIM

CANSLIM is an approach formulated by William J. O’Neil in his classic investing book, “How to make money in stocks.”  It combines fundamentals and technical analysis into a cohesive strategy.

Use a CANSLIM Stock Screener Strategy To Beat the Market

Below we will summarize the key elements of the strategy:

C  – Current Earnings.  Has the company made a strong recent earnings announcement, which is considerably more than the earnings one year previously?

A  – Annual Earnings.  Does the company show good earnings growth for the past five years?

N  – New Products or Management.  Has the company innovated its product base or injected new management to seek higher performance?

S  – Supply and Demand.  Does the stock have an increasing demand in the market place, is volume increasing with the price?

L  – Leaders.  Is the company a leader in its marketplace?

I  – Institutional Ownership.  Does the stock have some institutional ownership, but not too much ownership?

M  – Market Direction.  Understanding the overall market direction is important to be able to time your purchase of the stock effectively.

Advantages

The CANSLIM method is a well thought out strategy combining fundamental success factors with market timing.

Disadvantages

A lot of people follow this method so it can be difficult to implement successfully.

Average trade duration

Medium Term – months to years

The effort to maintain the strategy

Medium

Risk Rating

Medium

Section Summary

In this section of the training course, we reviewed six different types of strategies utilized to try to make money in the stock market.  You should try to adopt the type of trading strategy that suits your style of trading and the amount of money and time you can invest.  Each has its own unique advantages and disadvantages.

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