Phillip Fisher once said: “The stock market is filled with individuals who know the price of everything, but the value of nothing”. Actually, this is true, but is the real value what drives the stock markets today? Since the introduction of the derivatives market back in 1987 nothing is the same regarding the financial markets activity. Due to the domination of the Derivatives, the financial markets today have turned to 'shorterism' and thus they are trading the news more than they are trading real value.
A smart investor is an investor and a trader at the same time. So when the time is right he must trade the news and other times he must trade real value. We could say that the news-trading is more suitable in short-term periods while real-value trading is more important in long-term periods.
Trading Stocks Strategy
In this article, it is presented a strategy to trade stocks focusing on real value. This strategy is clearly investing-oriented and involves long-term thinking.
4 Simple Steps to Choose and to Trade Stocks
Here are the four (4) steps:
Step-1: Define your Investing Profile and Choose a Market
In order to define your investing profile, you must answer the first three key questions. Here are three questions:
1) What is your available capital and for how long it will be available?
2) How many total losses can you suffer?
3) What annual returns can make you happy?
If you hold a medium capital and choose to invest seeking high returns you will probably choose aggressive stocks within aggressive industries (for example technology stocks on Nasdaq). On the other hand, if you are risk-averse you will probably choose the safety of the blue chips listed for example on Dow Jones Industrial. If you are trading CFDs or Binary Options or any other Derivatives you can adjust your risk exposure by altering the rate of leverage you are trading. The stop-loss orders can narrow your risk exposure furthermore, especially if you trade derivatives.
Step-2 Define the Master Trend
I will not try to confuse you by analyzing how technical analysis may be used to evaluate the master trend, instead, I will give an easy tip:
→ When an Index (for example Dow 30) is above its 260 day moving average the master trend is considered bullish
→ When an Index is below its 260 days moving average the master trend is considered bearish
Keep in mind that there are some funds that are selecting their trading periods only by using a moving average. Depending on the selected market and your accumulated experience you can use more sophisticated ways to evaluate the master trend.
Step-3: Select and Compare Industries
You must not pick any stocks before you focus on an industry first. The industry should be chosen by performing comparisons upon industries and the General Index. New technological or other developments can make an industry a future star or a future victim. Try to find the stars. If you can’t find the stars concentrate on technology that usually ‘runs’ during bullish markets. Technology means industries like the Internet or the Biotechnological sector.
Measuring and Comparing Industry Value
In general. the industry's value can be calculated by making comparisons using ratios such as:
1) P/E or EV/EBITDA (these are ratios measuring profitability, you must use both past data and future forecast). Don’t forget that high-growth industries can justify high P/E ratios (for example P/E=30) while static industries can not justify even if P/E=10. To measure growth over time in combination with profitability you can use also the P/E/G ratio (Price / Earnings / Growth).
2) Industry Performance over the past 52weeks (compare the average returns of the industry to the general index or other industries' performance). For example, since the year started the General Index of a Stock Market has performed +20%. In such a market, an industry that has performed +5% can be considered undervalued while an industry that has performed +40% can be considered overbought.
My tip here is to choose at least two different industries in favor of your portfolio diversification.
Step-4: Select your Stocks
If you have now chosen one or a couple of industries, it is time to select your stocks. As an easy start, we are interested mainly in market leaders, in other words, companies holding the greatest market share at a national or international level. Leaders are the first choice of fund managers and that is important. Here are some more filters to pick the right companies within a chosen industry:
1) P/E and EV/EBITDA Comparisons
2) Corporate Debt and other Liquidity Comparisons
3) Past and Future Investment Comparisons
4) Management Past Performance Comparisons
And of course focus also on:
5) Stock Performance Related to the Industry’s Performance, during a certain period (for example since the year started)
The General Trading Rule you must Never Forget
Whether you are trading classic stocks or CFDs or any other instrument keep in mind that portfolio diversification means surviving.
- Diversification in terms of different Markets, Industries, Companies, and Currencies.
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■ Trading Stocks & a Winning Strategy
G.P. for TradingFibonacci.com (c)
