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A Simple Stock Market Trading Strategy With Low Risk, But High Returns
There are two broad philosophies in the world of stock investing. The first is fundamental analysis and the second is technical analysis. In this article, we will discuss a low-risk approach that combines technical and fundamental analysis into a strategy that can deliver excellent returns. Fundamental analysis is used to find the strongest companies in a particular sector, while technical analysis is used to find the general trend of the market and the exact time to execute a trade.
Trading Strategy Overview
This type of analysis uses broad economic indicators and company financial statements to select the best company to invest in. The basic framework that can be used to carry out the analysis is given below.
Determine the current market trend.
Find a list of companies that align with your personal values.
Analyze each company and find the strongest ones.
Use the charts to choose the right moment to trade.
Determine the current market trend
Dow Theory is a set of ideas formulated by Charles Dow from 1882 to 1902. Dow believed that a trend has three parts, primary, secondary and minor. A primary trend can last for years, secondary trends are corrections to the primary trend and can last from three weeks to three months, and minor trends are corrections that last from a few hours to a few weeks. Here is the main or primary trend of interest. A primary trend according to the Dow has three distinct phases:
Accumulation Phase: This is the stage where the most astute investors buy.
Public participation phase: This is where most technical analysts start buying because prices are rising and business news is good.
Distribution Phase: During this phase, economic news is good, newspapers publish positive stories about the stock market, and when public participation in the stock market increases. This is where savvy investors start to “distribute” before anyone else starts selling.
It is important not to buy during the distribution phase or when the primary market trend is down. Markets have cycles of about 4 to 5 years where they go up strongly, followed by a period of about a year when the primary trend is down and market prices simply fall. Be aware of where the markets are in their cycle and when stock prices are overpriced as it is not wise to buy at this stage.
Find companies that match your values
It is important to choose companies that you can relate to as an individual. Analyze all the things that interest you and the values you associate with, then choose a company that aligns with that. For example, if you love restaurants and eating out, check to see if the restaurant chain you love is listed on the stock exchange. If you believe in them and their value, then that’s a good place to start. If you do not approve of gambling, then it would not make sense to invest in a company that focuses on casinos or sports betting. Yahoo Finance has an extensive list of stocks and the sectors they belong to, which will allow you to find a company to connect with.
Once the list of companies is written down, the next step is to analyze each company to determine how strong it is in its industry. We look for companies that are so strong that they have a monopoly in their industry. No other company is better or more productive than them in their particular niche. The easiest way to find out is to look at the following information:
- Sales figures must be increasing in the last 5 years.
- Cash flow must be increasing in the last 5 years.
- Return on investment. The return on investment must be increasing in the last 5 years.
- Net earnings per share. Earnings per share must be increasing in the last 5 years.
- Equity or net worth of assets must be increasing in the last 5 years.
The growth estimate for the next year must be above 20%.
The growth estimate for the next 5 years must be above 20%.
- Earnings surprise must be positive for the last two quarters.
This information can easily be found on yahoo finance or the brokerage platform you use for online trading.
Use the charts to choose the right moment to trade
At this stage, we move from fundamental analysis to technical analysis. Charts are the best way to determine the right time to execute a trade. When looking at a company’s price chart, there are three important things to check.
Make sure the current trend of the stock is up.
The stock price must be above the 20-day moving average.
The ADX indicator should be moving up and should be below 40.
The above three checks will confirm that our stock is in a strong uptrend and that we can buy with confidence. The biggest risk we are exposed to is 1% of our capital on any trade. Our stop-loss must be set at a price lower than our purchase price, and the amount of our loss must not exceed 1% of our capital if we reach this stop-loss. If our share price moves up, adjust the stop-loss so that we do not lose more than 1% of our capital if the stop-loss is reached.
Exiting the store
The key is to trade as long as possible. This will ensure a big win but a small loss. A signal that can be used to exit the trade is if the ADX indicator crosses 40 and the indicator begins to visually flatten. This means that the strength of the trend is starting to diminish and it is time to exit the trade. Constantly moving your stop-loss to follow the price increase can also get you out of the trade.
The above method uses fundamental analysis to find companies that are strong in the market and then technical analysis to execute the trade. A quality company with strong economic fundamentals may experience price corrections, but the primary trend will be upward. If a bullish trend is detected early enough, good profits can be made with very little risk. The tactic of using a moving stop-loss will also reduce the risk of losing large amounts of money. In summary, you will have big wins and small losses, and even if the win/loss ratio is even, you will still make good profits.
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