Return to site

Winning Strategies for Beginner Investors (Part 2)

· Business

Company size

There are a number of investors who intentionally limit their choice of stocks from companies of a particular size, either in terms of revenue or market capitalization. This is done ordinarily by classifying companies according to market capitalization (“cap”), namely as micro caps, small caps, mid-caps and large caps. Over a long time period, bigger companies show higher returns than smaller companies do. Some investors thus believe that the size of market capitalization of companies has a great bearing on how the market responds to these companies; and the actual proportionate revenues provide a reliable indication of relative investment potentials. The generally-accepted classification followed by investors is as shown below:

Micro cap – Not more than $250 million

Small cap -- $250 million-$2 billion

Mid cap -- $2 billion-$10 billion

Large cap – Not less than $10 billion

Most publicly-traded firms are classified as micro or small caps. Statisticians are of the opinion that the apparent success of smaller businesses can be attributed to "survivor" bias rather than solid excellent performance, since the majority of the databases utilized for the tests conveniently removed bankrupt companies, up to recent times. That is, excluding bankrupt companies aided significantly in stacking the odds of success in their favor. This issue, however, remains debatable.

Screen-based investing

The “screen” method of investing is resorted to by many investors, which involves using "screens" to choose investments while applying various quantitative criteria to evaluate those companies that satisfy their criteria. Because of the ease and convenience of the method through the use of computers, it has gained a lot of practitioners. These screens can display various numerical values describing a company's status as well as its stock through different time periods.

While there are investors who use these screens to come up with interpretations of fundamental relevance to the business in general, many others utilize screens as “robot-like models" that simply point them to which ones to buy and sell. They claim that this process takes away the emotional factor in the investing process; although others think otherwise and say what you remove is the intelligence factor. Eric Ryback is widely known for his use of screens as a starting step in investing; while James O'Shaughnessy among the known proponents of screens as a pure mechanical system. As a beginner, you have to decide how you play – with the heart or with the mind or with both.

Momentum

The momentum of investing involves finding companies which do not only show good performance but also doing so well that they deserve celebrity status. "Well" is the term used to describe companies that stand out among all public companies that investors expect to show positive performance? Momentum companies, therefore, are those which frequently surpass estimated earnings per share or revenue by analysts, or post high quarterly and annual returns and sales growth compared to other firms, especially when the growth rate climbs from one quarter to the next. Such growth is a strong indication that the company is apparently doing the right things. Often, such high comparative strength is a category in momentum screens, as these investors seek to acquire stocks that have overtaken the rest of the stocks in recent months.

CANSLIM

CANSLIM is an approach originated by William J. O'Neil, who merged quantitative analysis and technical analysis, as contained in his book How to Make Money in Stocks. In O’Neil’s newspaper, Investor's Business Daily, we are told that the "C'' and ''A'' in the formula CANSLIM urges investors to find companies with fast-growing Current and Annual earnings. ''N'' is for New, to refer to business factors, such as new products, new markets, or new management. ''S'' represents Small capitalization and big volume market demand. ''L'' asks investor to determine if the business is a Leader or Laggard. ''I'' helps to spy out for Institutional sponsorship; and ''M'' focuses on the Market direction. Originally, O’Neil published Investor's Business Daily as a means for investors to apply CANSLIM; but it has turned into a general business publication patronized by all kinds of investors. CANSLIM formula incorporates features of another type of analysis -- technical analysis.

Quantitative analysis pitfalls

Since quantitative approach depends on screens which all people can see and as digital technology becomes more affordable and accessible, many of the pricing inaccuracies quantitative analysis discovers are eventually erased. Hence, if a certain screen has produced 40% yearly revenues and everyone hears about it, leading to large inflows of money into the identified companies, the returns will suffer gradually as a result.

As "unclear" as fundamental analysis may seem, sometimes having a little insight about the business you are buying can lead to a clear advantage. For example, if you utilize a high-comparative-strength screen, you must check at all times to see if the companies you discover have grown in price as a result of a merger or an acquisition. In that case, chances are the price will remain as is, even if the "screen" that picked this company had historically high annual revenues.

Technical Analysis -- Buying the Chart

What happens if you become fully convinced that all facts about publicly-traded companies were completely disseminated, giving no one any advantage whatsoever by either evaluating the business or interpreting the numbers? What does that leave you to do? You can try forgetting about beating the returns in the market by buying an index fund. There is another option which investors have taken: trying to build a set of charts that might show how other investors evaluated a stock at any certain time, specifically finding traces of large institutional investors which often lead to very significant price fluctuations. This approach, which some investors apply, is referred to as technical analysts and uses charts that practitioners believe can bring information and insight into the psychology affecting the behavior of a stock. As it is in other areas, many chart purists exist, although some investors turn to charts only to time investments after they have checked out the charts through the eyes of a fundamental or quantitative analyst.

We cannot present a step-by-step process to describe technical analysis; but various several tools exist. The most significant indicators appear to be definitive chart patterns portraying certain price fluctuations during times when the volume of trading hits a particular level. Some of the often used charts are the following: logarithmic charts, point-and-figure charts, Japanese candlesticks, and others.

Technical analysis pitfalls

Technical analysis is based on the presumption that specific chart patterns confirm indications of market psychology pertaining to either a particular stock or the market in general at crucial points. So far, much of the statistical research academics have conducted to assess whether indeed these chart forms really predict has not confirmed the supposition, as discussed by Burton Malkiel in his book, A Random Walk Down Wall Street. As with supposed new cure-all drugs or supplements out on the market, much of the trust in technical analysis revolves around anecdotal experience and not some form of durable statistical validation, unlike some fundamental and quantitative approaches which have so often successfully predicted future events. As one critic quipped, “Technical analysis is essentially as useful as reading tea leaves.”

Trading -- Doing What Works

Trading has gained such popularity, taking on celebrity status at par with such figures as Michael Phelps and Pokemons. And this happened while trading commissions have come and gone and growing numbers of people have gotten their hands on real-time information about stock prices. Commonly, traders utilize a medley of fundamental, quantitative and technical approaches with a short-term direction. This tends to make trading a high-strung activity where an investor hopes to catch a few percentage points from each trade. Hence, in spite of its popularity, trading is never a structured, rational compilation of information we can reduce into a small primer.

So many beginning investors who started out hypnotized by the perceived pie-in-the-sky appearance of   trading, often lose a lot of money before discovering that with thousands of other traders running after the same pie, oftentimes, the fastest, most experienced, and most well-equipped technically are the ones who make money -- and these are usually the veteran investors and not novices. Successful trading, as every trader will emphatically say, demands meticulous focus, discipline and diligent work; so anyone who thinks that using a Quotrek while holding down a job at a fast food outlet might want to reconsider.

Arguments against trading

Obviously, trading requires much time to become good at it. Yes, we have heard of many superstar traders; but we often forget that these traders have the equipment and the time of day – perhaps, the whole day -- to trade consistently. It may sound discouraging; but considering the time and effort that most successful traders put to engage in trading; the prospects for beginners to attain the same benefits with less effort and fewer resources is quite low. With the amount of money involved in the stretch of a day to a year investment time-period, a person with limited time will potentially gain greater success in a personal business venture on a long-term basis than diving headlong into a Vegas-like environment.

Summary

For now, you may be capable of naming and defining accurately every acronym of approaches we have discussed, such as CANSLIM and GARP. Likewise, you have understood some underlying investing principles minus those odd acronyms. You know the gist of such methods as fundamental, quantitative, and technical analysis used in choosing stocks. Most probably, you will eventually devise your own peculiar style of investing. And as you increase you knowhow and expertise in this exciting adventure, you will build your personal investing philosophy that will fit your own special needs and objectives perfectly.

All Posts
×

Almost done…

We just sent you an email. Please click the link in the email to confirm your subscription!

OKSubscriptions powered by Strikingly