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Trending conditions are preferred vehicles
for public investing because your money can work harder for you with
less involvement.
Trading conditions are more suited for
professional (and contrarian) investors, because price swings are
shorter in duration and capital leverage is used to magnify the returns
(as well as risks).
In our study of trading systems and market
timing, we have come to few important findings about consistently
making money in the stock market.
Ideal systems are usually trend following,
that do not over-trade (protect from excessive commissions), but yet are
sensitive to large market swings (thus catching large price movements).
Buy and hold strategy commonly
promoted to public investors is a fairly risky way to commit your hard
earned funds, and it's only one sided since there is no shorting.
Though buy and hold is a valid investment
philosophy, you don't get the benefit of compounding your money in the
down market moves (since you are holding).
Seeing your stock go:
from $1 to $9,
then to down to $3,
then to rise to $19,
then down to $9...
- nets you $8 profit in the end - which is
still a great return in this example.
As you can see below, riding a stock up and
down nets you much better results since you are following price trends.
Assuming we only capture half of each move,
here is a hypothetical scenario:
($9-$1) / 2 = $4
($9-$3) / 2 = $3
($19-$3) / 2 = $8
($19-$9) / 2 = $5
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Total: $20 profit
$20 versus $8 is a much better strategy.
Now consider this - as a clincher! If that
stock drops to $0.50 you end up with a loss of half of your equity, and
what's worse - you need to now double your capital to regain your
original equity.
You painfully lost 50% of your funds and now
you need 100% return just to break even!
Trading like this is hopping on the bus to
randomly take you to your desired destination - it's far too passive and
ineffective in terms of leveraging time and price swings.
The second system (swing trading) catches up
and down market movements and actually makes good profit in the last
slide netting you over $24 on your $1 original investment. Again,
remember that we are profiting from only 50% of the moves to simulate
losses and cost of trade execution.
In the end, it's the same market, same
opportunity for all - but greatly different results and emotional
outcomes.
Your market timing method has to be in sync
with your investment philosophy and trade selection process.
Ideally, a public investor should trade
smaller lots, around 5-15 trades a year, hopefully capturing major price
swings that can be observed on most stock price charts. This type of
investing is not passive, but also not too aggressive (at the same time)
where the cost of commission impedes your profit accumulation.
Generally, 70% of the successful trading
systems use some type of price breakout model or moving averages that
ensures catching of major price swings.
Average annual returns usually range between
20-40%. Even such a modest strategy is enough to produce great long term
returns through compound leveraging. This leads to the topic of money
management. |
