This article was featured in the December 2006 ASX Investor Update email newsletter
To Download your FREE MP3 AUDIO of this article and more, simply Login/Register at our Free Stock Trading Downloads webpage.
Jim Berg explains how a solid trading plan combined with sound fundamental and technical analysis will help beginners on their way to successful investing.
Intuitively we all know we should buy low and sell high. Yet many inexperienced traders, and even some seasoned traders and investors, manage to do it the other way round. They get caught up in the irrational exuberance of the market. They end up buying near the top, then holding as prices fall, finally selling somewhere near the bottom when the ‘pain’ gets too hard to handle.
Key factors in long term successful investing are a set of rules or trading plan and the discipline to follow that plan. The market is no different. Success in the market starts with having the discipline to protect hard earned capital and survive, through learning how to minimise losses. The next step is to thrive by growing a portfolio through protecting profits and continuing to minimise losses.
Step 1 - Borrow a Trading Plan
One of the easiest ways to develop a trading strategy is to ‘borrow’ a system from another trader such as an established author or educator. The borrowed system is used as a base to test and eventually build a trading strategy that suits the investor’s personality and trading philosophy.
Without an experienced guide, learning to trade the share market can be very expensive. It is much easier to learn from others’ experiences than having to repeat their mistakes yourself.
Step 2 - Combine Fundamental and Technical Analysis
Some investors rely on a company’s fundamental performance to make their investment decisions. Other traders ignore fundamental analysis and rely completely on charting and technical indicators. Technical analysts reason that everything worth knowing about a company is reflected in the current price action.
My personal trading system combines both fundamental and technical analysis. This helps improve the balance of probability of success by finding fundamentally sound shares which have been rising and timing the entry to buy after the share has recently dipped and then resumed its uptrend.
I find fundamentally sound shares from broker recommendations, newsletters, internet, media and specially designed software. My strategies add some science to the well worn cliché of ‘buy on the dips’ through the use of easy-to-follow indicators. This results in me reacting to a move in the market rather than trying to predict a bottom from an oversold condition.
I find this common sense approach helps those inexperienced at trading shares to understand the share market and take the first steps to investing successfully.
Not all trading systems are necessarily trend following, but I find the advantages of following the trend is significant as it increases the possibility of ‘being right’.
At any given time there will always be markets that are in a rising trend. Identifying markets that are reversing trend and those that are already in a trend is an important part of my trading strategy.
This big picture view of the market is done with weekly charts. A market can trend for weeks, months or years before reversing direction. I can’t predict when a trend will end so I trade with the trend until technical weight-of-evidence produces enough warning signals to shift my attention to other, more favourable, markets.
Chart 1 is an example of a share in a rising trend based on a weekly chart. This share met my software fundamental criteria:
- Market capitalisation greater than 150 million
- P/E Ratio less than 25 or PEG Ratio less than 1
- Return on Equity greater than 8%
- Earnings per share growth greater than 8%
- Net Profit margin greater than 0.01%
Chart 1
Prices are making higher highs and higher lows and the closing price is above a rising moving average.
The rising market condition is established with analysis of the sector and the share using weekly charts. My entry point is based on a volatility move from the recent low and in the desired direction.
Chart 2 is an example of two volatility entry signals.
Chart 2
Within a rising weekly trend we have retracements in October and February to oversold levels, as measured by the indicator Relative Strength Index.
An entry signal occurs when prices resume the rising trend. The amount of the move needed to trigger an entry signal is based on a multiple of price ranges over a set number of days.
The volatility entry signal is designed to:
- Enter rising markets at time of low volatility
- Enter before next move up on rising volatility
- Enter near recent low
- Protect against entering during times of high volatility
Technical and fundamental weight-of-evidence is combined in both types of setups.
Inexperienced traders need to understand that a trading system is more than just a method of deciding where to enter the market. Knowing where to get in is important, but not as important as knowing where to get out.
Nor is the entry point as important as risk management, position sizing or understanding trader psychology. Each one of these is an important component of a comprehensive and disciplined trading system. By mastering these, investors and traders increase their chances of long term survival and profitability in the market.
In summary:
- Borrow a trading system that works and which suits you
- Change it to suit your personality and trading philosophy
- Back-test the system to determine if it works on historical data
If it fails to make money historically, change indicators, alter parameters and re-work the system until you are confident it will generate profits. A system that is unable to make money on historical data is unlikely to make money in real time.
Step 3 - Practice
When you are confident in your trading system, trade it in a virtual competition such as those provided on the ASX website. In a competition you risk no money but experience many of the emotions you will experience when risking your hard earned dollars in real time trading.
You will feel and learn to control the stress and anxiety of trading caused by indecision, fear, greed, anger, denial, hope, and revenge. A virtual trading competition will prove an invaluable experience while causing no damage to your equity balance.
There are complete books written on the various topics presented in this article. For many inexperienced traders, this is the first step on a journey that will include exploring each of these topics in greater detail when it is more appropriate and convenient.
It is a journey that will never end as it is not possible, or necessary, to know everything there is to know about the markets and trading. It is a never-ending quest for knowledge that will, for most investors, prove the saying ‘the journey is as important as reaching the destination’.
To discover more about how to get started successfully or how to improve your current performance in the market Click Here Now.
JOIN OUR FREE CLUB:
"Start Your Own Profitable
FIRST, sign up now & we will
(Be assured - this is a private mailing list and will never be sold or given away for any reason. You can also unsubscribe if you ever want to.) |
