Stock Trading: How I Trade!
Tuesday, October 18, 2005 Permanent link to this post
In a previous post I had mentioned that I have been reasonably successful in my stock trades. I follow my own investment strategy and it has served me well. Here is what I do:
I basically use a very simple philosophy: "Markets Overreact!" - so when I see an evidence of market overreaction - I put in a contrarian bet. While markets are quick to overreact, they are also quick to correct (at least partially) - so I wait for the correction - book my profits and leave. It sounds so simple - but executing it can be quite difficult. It needs discipline and patience. This is how I manage to control the process:
Trading Strategy 1: Buy fundamentally sound stocks that market is unnecssarily pulling down
Today's Trade: I bought ASD at 36.35. ASD has very good fundamental and has growing revenue. The stock has dropped by 16% today after below expectation quarterly result. It now has a forward PE of 15 and market cap of 7 billion. To me - its an ideal candidate. I entered at 36.35 in the morning and its already up to 37.50. I am planning to exit at 38.10 and I have a stop loss put at 35.25. I will post later how I fared on this bet.
Update: I lost on the above trade. The stop loss got triggered - so about 4% loss. However, my stock pick was validated - today the stock is at 37.10 - about 2% up than my buy price...
The second stratgy is the opposite of the first. Its about selling short the stocks that have been pumped up artificially. I am not a big fan of this one but use once in a while when something obvious comes up. Recent example is LRCX - it rose up so quickly that it had to retreat. I sold it short and made a decent margin. I will post the "how-to" for this strategy in the next post.
I basically use a very simple philosophy: "Markets Overreact!" - so when I see an evidence of market overreaction - I put in a contrarian bet. While markets are quick to overreact, they are also quick to correct (at least partially) - so I wait for the correction - book my profits and leave. It sounds so simple - but executing it can be quite difficult. It needs discipline and patience. This is how I manage to control the process:
Trading Strategy 1: Buy fundamentally sound stocks that market is unnecssarily pulling down
- Stock selection is key here. I look for stocks that are profitable (no losses in last four quarters), have P/E of less than 20 (preferably less than 12) and growing revenue. Further, since we are placing short term bets, we need our stocks to be volatile - so I look for stocks that have market cap of around 1-2 billion. I would still trade in stocks of about 10 billion, but after than stocks become too rigid in their movement. On the other hand, if the stock has low market cap then it would get manipulated - so I look for minimum market cap of 200 million dollors. Last thing - I make sure that the stock is liquid - at least 500,000 trades per day.
- Now, every day - look at all stocks that fell by more than 10%. See any stock that fulfills the above stock selection criteria. After that - take a call on future movement of the stock - this is where experience counts. Look at the charts, look at the PE numbers, volumes and past history and form your opinion about whether the stock is being punished for bad news that does not significantly affect the fundamentals of the stock.
- Once you take your call (and if it says that the stock is good and you should enter) - put a limit order for a price you expect the stock to fall to. Always put a limit order - never a market order.
- Then you wait for the trade to execute. The moment it does its time to make sure that you do not lose too much money in case you have made a wrong decision. I normally put a stop loss order of 4% below the transaction price. Thats a loss I can take.
- Thats it - just relax and let the market do its thing. I normally put an e-mail alert for 5% over the transaction price - and when that alert gets activated - I cash in. Never be greedy in this business - I exit at 4% loss and 5% rise. This means that I just need to be right in my stock selection half the time for breaking even (the difference of 1% is for taking care of transaction cost).
- How do you maintain discipline in the above process: first - be cautious in stock selection. second - exit at 4% loss - do not wait for the stock to turn around. third - don't get greedy - get out at 5% rise.
Today's Trade: I bought ASD at 36.35. ASD has very good fundamental and has growing revenue. The stock has dropped by 16% today after below expectation quarterly result. It now has a forward PE of 15 and market cap of 7 billion. To me - its an ideal candidate. I entered at 36.35 in the morning and its already up to 37.50. I am planning to exit at 38.10 and I have a stop loss put at 35.25. I will post later how I fared on this bet.
Update: I lost on the above trade. The stop loss got triggered - so about 4% loss. However, my stock pick was validated - today the stock is at 37.10 - about 2% up than my buy price...
The second stratgy is the opposite of the first. Its about selling short the stocks that have been pumped up artificially. I am not a big fan of this one but use once in a while when something obvious comes up. Recent example is LRCX - it rose up so quickly that it had to retreat. I sold it short and made a decent margin. I will post the "how-to" for this strategy in the next post.
Labels: Investing
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