I have been in the markets for more than 4 years. I use a fusion of – Fundamental & Technical Analysis in my trading. I am still in the process of figuring out what works in the markets but I am making good money consistently. In this blog, I thought I will write about my never ending search of holy grail. Also about the books / sources from where I learnt my skills and the strategies I use in my trades. Please treat this post as a course content book for, say, a diploma in stock market which will help you cut short your learning curve.
The line between investing and trading has eroded over time. Investing in the true sense is getting income through dividends paid by the company. To get regular income like dividends, I would rather invest in Government Securities which are risk free. In my methods, dividend is only a cushion for risk. Then came Ben Graham who bought stocks which were trading at a price less than their asset (book) value. His method worked when most of the companies listed in the exchange were old economy with asset heavy business models. Now, everyone is only interested in the price appreciation which makes everyone a trader. Per tax rules, if you buy and sell within an year, you are a trader. If you hold it for more than 12 months, you are an investor. Fundamental guys try to glorify their analysis but at the end of the day, price has to move higher than your purchase price for you to make money. My basic thought process, irrespective of timeframe, is:
Buy Low, Sell High or Buy High, Sell Higher
If you are a newbie and have never traded before or you don’t understand a company’s financial statements, please read the beautfiul primer by Zerodha.
I would definitely suggest you to explore the different types of trading / investing but once you are done exploring, try to find the ONE method that you identify the most with and build a plan around it. I have attended many webinars, workshops and talks related to stock markets in the last 3 years. In every event of those, I would pick up a new strategy. Try to apply it the markets immediately. After the initial luck, I started making losses. The reason for this is that they were not MY strategies and they did not suit MY style / mentality. Also, I was playing on borrowed conviction which never works in the long run. Hence, find out what kind of trader / investor you are and then build YOUR strategy. Psychology has to be in place before you even think about adding funds to your broking account. Psychology includes discipline as well. If you are not disciplined in personal life, it is very difficult to make money in the markets. Your habits will reflect in your trading, be it profits or losses. In fact, through trading you will learn new things about yourself which you never knew.
Remember – More knowledge is not more wisdom!
Fundamental analysis (FA) is a method of measuring a company’s intrinsic value by examining financial statements of the company and related economic factors. Fundamental analysts study anything that can affect the company’s value, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors like the effectiveness of the company’s management and past financial performance. The end goal is to arrive at a number(fair value) that an investor can compare with a company’s current price in order to see whether the company is undervalued or overvalued.
Basics of Fundamental Analysis:
- Five rules for successful stock investing – Pat Dorsey
- Value Investing, From Graham to Buffett and beyond – Bruce Greenwald
- Common Stocks and Uncommon profits – Philip Fisher
- One up on wall street – Peter Lynch
- Masterclass with super investors – India’s leading investors – Vishal Mittal
Cyclical Investing: (extension of Value investing)
- My Investing Guru – Kenneth Andrade
- Capital Returns – Edward Chancellor
- Mastering the market cycle – Howard Marks
I identify my framework with that of Kenneth’s and I love his style of investing. Unfortunately, Kenneth hasn’t written any books but has done a lot of interviews. Links to them in my twitter thread:
I tried to apply the concepts in the book – Capital Retuns – in Indian markets. This helped me build a framework for cyclical companies.
Expectations Investing: Potential future value of a company based on growth and profitability (extension of Growth Investing)
- Expectations Investing, Reading Stock Prices for Better Returns – Alfred Rappaport & Michael Mauboussin
- Charlie Munger’s framework and adaptation by Professor Sanjay Bakshi for Indian markets – “Relaxo Lecture”
Professor Sanjay Bakshi’s framework:
Value Investing: (Buy Low, Sell High)
- Prof. Aswath Damodaran (His MBA course – https://www.youtube.com/c/AswathDamodaranonValuation/playlists)
- Valuation: Measuring and Managing the Value of Companies – Mckinsey
- Warren Buffet’s letters to Berkshire Hathaway shareholders
- Poor Charlie’s Almanack – Charlie Munger*
Note – These 2 guys (Warren & Charlie) are outliers and I don’t think anyone can repeat what they have done but they are the foundation for Value Investing. Also note that I say “Buy Low” and not “Buy Cheap”. Cheap is not necessarily Value.
To understand various aspects of a company, you should read the Annual Report and Conference Call transcripts. To anaylse companies and their financial performance, I use Screener website where you can find all the listed Indian companies’ data in one place:
I use ValuePickr to see research work done by other investors on companies I am interested in. It helps me get a different perspective.
Technical Analysis (TA) is to evaluate investments and identify trading opportunities in price trends and patterns seen on charts. Technical analysts believe past trading activity and price changes of a company’s share can be valuable indicators of the share’s future price movements. Technical analysis assumes that a company’s share price already reflects all publicly-available information and instead focuses on the market sentiment behind price trends by looking for patterns and trends rather than analyzing a security’s fundamental attributes.
You can learn basic TA and psychology from these books: Mark Douglas (must!)with either Martin Pring’s or John Murphy’s*
I buy when there is a high probability trading setup with low risk. Following are the high probability setups I use:
- Darvas Box – All Time High, 52-week High, 6-month High –
- Mark Minervini – Volatility Contraction Pattern –
Watch the following videos after you read these 2 books.
- William O Neil – CANSLIM –
- Value Zone – Market and Price move from one zone to another. Each zone is a Value Zone. Fight between supply and demand. Buyers and sellers. Whoever wins, pushes the price in their direction. This book was the game changer for me! (will write a blog soon about my trades using this setup)
Quantitative analysis (QA) is a technique that seeks to understand behavior by using mathematical and statistical modeling, measurement, and research. Quantitative analysts aim to represent a given reality in terms of a numerical value. I don’t understand mathematical or statistical modeling. You will need a PhD in Mathematics or Statistics to do data driven trading. I am only interested in the measurement aspect of QA. As in, quantifying Technical or Fundamental Analysis to build trading / investing systems with complete set of rules for buying and selling.
There are 2 broad categories where we can implement Measurement QA – Trend following / Momentum investing and Mean Reversion. I am not covering Mean Reversion in this blog because I don’t know that method / concept.
- Trend following – a trading strategy based on the idea that markets move for long durations of time in a given direction, and one can quantitatively identify such a trend and ride it.
Capitalmind’s series on trend following
My Trading Guru – Trend following and Mechanical (rule based) trading – https://twitter.com/madan_kumar
- Momentum Investing – a trading strategy of buying financial assets that are showing strength and selling those which are showing weakness. This strategy is based on the age old tenet of cutting your losses and letting your winners ride.
“The key difference lies in the reference point used to identify a trend versus a momentum. For Momentum, we use the Performance of stocks as compared to other stocks in a given universe. In contrast, in Trend Following or Time Series momentum, we compare the current price of a stock/Index with its historical price.”Capitalmind
Prashanth Krish’s journey in Momentum Investing – https://twitter.com/Prashanth_Krish
Capitalmind’s series on Momentum
My Quant Guru – https://twitter.com/jace48
He recommended this book on how to apply math in trading. It involves a lot of Statistics and Data Analytics. Don’t waste time if you don’t know any of those.
- Systematic Trading –
Phew, thats how much you will have to read to get a Diploma in stock market. But you promised us a holy grail? The sad truth – there is no holy grail! If there was one, everyone would be making money, right? Trading and Investing are marathons and they do not have any short cuts. No free lunches. You will have to grind it out and lose some money in the process. Consider it as tuition fee.
Fundamental Analysis – What to buy? Undervalued / Cyclical / Quality / Growth
Technical Analysis – When to buy? High probability setups with low risk
Quantitative Analysis – How much to buy? Who are the leaders in the sector? Trend strength / Relative momentum ranking / Maximum Drawdown / Position Sizing.
- Load your account with few thousands. Trade, Invest. Lose money. Get a feel of the market. Decide if are you are capable of handling the emotions. You might feel that you are okay with 20% drawdowns but only when you experience a 20% drawdown in real life, you will know if you are okay with it or not.
- Read again. THINK! INTROSPECT! Choose your style. Identify your psychology. You need not use all 3 sciences. If you are comfortable with Technical Analysis, then just stick to charts. Don’t look at fundamentals. Don’t run behind more information or knowldge. More knowledge is not more wisdom. Less is more!
- Go through charts. A lot of charts. Study companies and their financial performance. Create a set of rules. Backtest those rules to see if they made money in the past. Finalise your strategy. I stress on backtesting because I have used almost every technical indicator available but I either lost money or couldn’t scale up because I hadn’t done the backtest. Only a back test will reveal if a certain indicator has an edge or not. (Personally, I do not use any indicator. My charts are clean and I use only price action with volume.)
- Implement the strategy rules with Discipline and Money / Risk Management (read up about this as I am not an expert, in trading lingo its called Position Sizing). A system is nothing without discipline. If you can not control your emotions, forget stock market.
- Start with small capital.
- Trade short term to create capital
- Invest long term to build wealth
- Always have a stop loss!
- If you are making less than 12% on an average every year, better to stick to Index funds. You will get the market returns with less effort.
“All you need is one trading pattern to make a living! Learn first to specialize in doing one thing well.”Linda Bradford Raschke.
What not to do!
- DO NOT START WITH FUTURES OR OPTIONS OR LEVERAGE. YOU WILL BLOW UP YOUR ACCOUNT. NOT JUST ONCE. YOU WILL LOSE EVERYTHING.
- DO NOT BUY OR SELL BASED ON STOCK TIPS YOU RECEIVE ON SOCIAL MEDIA. DO YOUR RESEARCH. BUILD YOUR OWN CONVICTION.
- DO NOT FOLLOW A LOT OF PEOPLE ON SOCIAL MEDIA. YOU WILL BECOME BETTER IF YOU STAY AWAY. INVESTING/TRADING IS BEST DONE ALONE.
The process –
You will lose big
You will lose small
You will breakeven
You will make small profits.
You will make money consistently. (It will take few years to get there)
“Patience and Discipline are the holy grails in the stock market!”you-know-who
Will leave you with this
“A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts”Burton Malkiel
Good luck! (you will need a lot of that)