Building A Stock Investing Strategy

My friend Adrian over at Shareyournumber.com asked me to write a post on how to build a strategy to invest in stocks.

To check out the post and comment click here. Enjoy!

Letting The Winners Run

Fear is a dominant player in the markets. Stocks drop, people get scared, and the stock drops more because people are selling...because their scared. Good companies selling at depressed values make excellent opportunities, if you can ignore the fear.

The same applies to stocks increasing in value while you hold a position in it (always a good thing). As the shares increase in value, some people become more and more afraid, especially in these market conditions (April 16, 2009), the questions pass through the mind... is this a true rally, or is this stock about to slide back down, erasing all profits earned.

It is important to ignore fear in both examples. This is accomplished by committing to an entry price and exit price BEFORE taking on a stock position. Before entry, you are thinking clearly, unaffected by the bombardment of emotions as the share value fluctuates. The key to allowing your winners to run is to stay the course and allow the value to raise to the predetermined price...then sell.

A principle I recently acquired and have taken as my own is the 7% rule (found in Jack D. Schwagers' book "Market Wizards"). If you have a working theory about a stock, based on fundamentals and sound reason, take the position, but set a limit order to sell or cover after a 7% loss. This will keep you from losing your shirt on any one trade.

Market Timing

I left this comment on 7million7years.com and thought I might expound on it.

The term "market timing" reminds me of double dutch. With the jumper waiting on the outside of the ropes, waiting until they believe they have the rhythm of the ropes, and can predict them.
I tried this a few times in grade school and got whacked in the face.

This is the type of trading you don't want to participate in. It may turn out well a few times, but for the long term, you will inevitably lose money.

While double dutch is the sport I liken "market timing" to, consistent, successful investing is more like surfing. The surfer waits patiently for the perfect wave, there is no rhythm or signal to tell him the wave is coming, it just arrives (there is a rhythm to ocean waves, but to catch the perfect wave takes patience). He can either take advantage of it without hesitation, or let it pass him by.
When observing a market inefficiency, I know its time to invest, and the opportunity won't be around for long. This has nothing to do with "timing" and more to do with fundamentals and anticipating the emotions of the market.

How to Determine the Market Bottom

This is an obvious question because if you can determine it correctly, just about any investment you make will be profitable.

The bottom is... when you think the economic world as we know it will end, very soon there will be no stock market and your prediction of the future economic structure of the United States is a hunter - gatherer society.
That is the bottom and it is now time to buy. This is based on the assumption that because you are experiencing this fear, everyone else is as well. During this time only the logical can stand back and notice everyone has lost their minds and the deals of the decade are being presented.

The individual who can pull the trigger at this point, manifests discipline and courage. Basically a complete absence of fear while maintaining faith that people will continue to be people and buy goods and services, hence lifting the economy, spurring optimism which only spurs more buying, turbocharging the profits of good companies as well as their shareholders.

Just be mindful of the flipside...when people are too greedy. This marks the top of the market and the perfect time to sell.

Negotiate With Patience

As I learn more and more about making money, I see several patterns which seem to emulate over and over. One of them is the importance of buying low and selling high (obviously). And in order to do this effectively, having patience on hand will always give you the edge needed to buy low, thus giving you the ability to sell higher.
An example of this could be buying a used car. If you have the luxury of time and the ability to use patience, a quality used vehicle can be purchased for significantly less then if you were in a rush and needed to buy immediately.
Another example could be the purchase of stock, and using a limit order instead of a market order. Using limit orders effectively allows you to negotiate the stock price instead of simply purchasing whatever is for sale at that moment, although a little patience may be needed.
So if you happen to be in the market for a car, or shares of XYZ, don't only exercise good judgement, but also take a moment to exercise patience.

Emotion Control

If it were possible to possess the ability to control your emotions, where the individual could at one moment genuinely feel the fear, worry and panic during a stock sell off, then just the next moment experience the sober, calm, rational and reasonable feelings which are more appropriate, this individual would possess an edge capable of earning wonderful returns in the stock market.
With discipline and practice I am attempting to identify the fear brought on from this automatic human response, repress it, and exercise intelligent rational trading behavior. Taking advantage of fearful, irrational and stupid prices available during panic stock sell offs.

Leave a comment and tell me what do you think of this strategy.

Account Status

Just transfered the funds received through my tax refund to my e*trade account. I'm currently making 3.45% interest on the money which is a whole percent less then e*trade was initially giving out but interest rates are going down and everyone is decreasing their rates so this comes as no surprise.
I've been playing with the funds in my virtual optionsXpress account at the same time as realizing how hard investing in the market is. I'm also learning a ton and loving it. I'm keeping a close eye on Anheuser-Busch at the moment.

Save

Following the last post about self-investing, I would like to start exploring other areas of investing probably considered more conventional.

I will be researching, writing and calculating how to invest. Assuming you are below the age of thirty (>80% of my investment funds will be in stocks), have some money to invest (meaning, you can afford to lose it) and are willing to accept more then average risk, these posts will apply to you. I have a fairly high level of risk tolerance and will invest accordingly. I understand the average investor will fail to beat the market and most are better off putting a portion of their paycheck every two weeks into an index fund, but this is not where I stand. I believe with the right system, earning quadruple what the S&P500 did this past year is not fantasy. (YTD percentage yield, as of today, the Vanguard Total Stock Index Fund (VTSMX) has lost -7.52%, so even index funds are prone to significant loss).

My plan right now is to save and start investing. I opened an e-trade savings account to help me do this, earning 4.01% interest at the present time. I have right now about $600 and will accumulate until I reach $1,000. At that point I will begin to experiment with different investment vehicles while sharing my gr0wing pains and results with this blog. I will choose stocks based mostly on my own level of confidence with that company's product, while supplementing decisions with a combination of fundamental and technical research.

I will begin investing within the next three weeks using Zecco as my preferred trading tool, chosen based upon it's reputation for free trades.

How I Pick Stocks

I've recently began exploring how to pick stocks utilizing intelligence and intuition using both technical and fundamental analysis with an emphasis on fundamental analysis. (allow me to state, I prefer not to allow outside opinions to dictate what stocks to invest in, i.e. Jim Cramer's Mad Money. Although if it happens, it happens)

I begin by visiting yahoo.com and following the side navigation bar to finance and selecting the index that I'm most familiar with. From the following page, I select components from the left navigation bar.

On the following page are a list of all the stocks in that particular index. At this time in my investment education I have not found a better way to investigate stocks to invest in but to scroll down the list and select component names I recognize and strike me as a company I find to have quality products, effective marketing and room for growth. I look back to my experiences with those products, if I had patronized the company before, what my experience was like with that purchase and if I planned to patronize that company again.