To the 5 people who are still reading this blog, I apologize for not writing any posts for the past 2-3 months. I was experimenting with several new strategies incorporating a technical analysis component in my stock analysis. I felt that, as an amateur investor, I could not compete with professional stock analysts, all of whom can read the same annual reports that I can read, and have the time and resources to do back channel checks that I cannot do. My only advantage is my small size, which means I can enter and exit positions without moving the price.
Early in this experimental stage, I tried several charting techniques, but eventually found that because they were too “black magic” and did not satisfy my rational side, I did not have the confidence to take large positions with them. Eventually, I found two technical factors that were backed up by academic studies and grounded in human psychology. Firstly, the stock market overeacts to events, and corrections and pullbacks occur with a greater than normal probability. However, I found that this mean reversion effect takes place over time frames of only 1-2 days, and is really suited for automated trading rather than human trading. Secondly, runs in the stock market occur with greater length and frequency than a random walk, a phenomenon called the momentum which has been attributed to many causes, including the the herding tendency of investors and to institutional investors moving prices when they enter or exit a stock. The momentum effect is most pronounced on small cap stocks, suggesting that the role of institutional investors is dominant. I figured that if I could try and spot stocks which are starting a trend, and then use manual fundamental analysis to figure out a plausible investment thesis and thus predict where the price is headed, I could hop onto stocks just when they are making a move, and then switch to other stocks once the move is finished, maximizing my returns.
For the past 3 months, I have used a strategy where I screen stocks with the ADX technical indicator to identify stocks which are in a new uptrend or downtrend, and then manually go through them to pick out the stocks where a plausible investment thesis exists. Often, I find that due to my fundamental analysis, I am able to predict quite accurately what price level the stock is moving to (stock prices often move to round PE values). This strategy, executed in the context of a rising market, has resulted in my outperforming the stock market by a significant margin. I found that if I cut my losses within 1 month if the stock doesn’t move as I predicted and let my winners run to my anticipated targets, my profits vastly exceed my losses despite the fact that I have only a 60-70% chance of picking winners.
Because I am not a long term stock holder with this strategy, and to keep my workload reasonable, my analysis of each stock will necessarily be much shorter and shallower than my previous analyses. In the future, I will be presenting my analyses as short blurbs about specific stocks instead of the more in-depth articles that I have been writing. I also intend to devote susbtantial time to the study of human psychology and how it interacts with the stock market to present opportunities that can be taken advantage of.
