Rules and strategies

 I will mainly invest in the Swedish stock market because I am Swedish and get better information here and understand this country better than others. It also feels simpler and  like an easy way to start. I will start in a very small scale and if time proves my methods to be working will apply it to the rest of my portfolios.

I am NOT Warren Buffet. I can not afford to buy a great company and keep it forever through thick and thin.For my main portfolio I will find some nice and stable long term investments as a foundation and add shorter term positions to it to be able to ride the coat tails of whatever stocks are currently trending. My goal is to find a screener that will find solid companies in a positive trend.

General strategy

Buy 20-40 stocks with a proven ability to make money. Either sell the underperformers or get rid of them with the help of stop-loss. Maybe a mix of 50% big stable companies that are performing well and 25% picked with Magic Formula and 25% picked using PEG might be a nice mix. My main purpose with this little project is to try to determine a good strategy in stock picking.

I will stick to stocks. Options, warrants etc are of little interest to me. I have no need for a get-poor-quickly scheme, I am good enough at losing money as it is. This is to me more gambling that investment.

Discipline…

This I lack a lot. I fall in love with my stocks and don’t want to sell them. So my main portfolio will probably remain relatively untouched. Due to this weakness I recognise the need for a strict stop loss policy. I will start with 90 % and see how it goes. I will set the trigger to 90% of the purchase price rounded upwards and the sell price to 90 % rounded downwards. This will most likely change during this experiment. Many times…

The Parabolic SAR technical indicator might be a great help in setting the stop loss levels. Heikin-Ashi might also be useful. These show the trend. When they become unreliable the trend is not strong. The question is do I want my short term investments in stocks without a strong trend? And why would I care at all for the long term investments that I plan on keeping for the next ten years?

Fundamental analysis

A companys fundamentals determines if it is a healthy company making decent profit. Preferably they run with a profit every year. I want it to expand and grow. Growth, should lead to higher profits and higher stock value. So I will try to research what criteria works best for filtering. I want a short list of maybe 20 companies or so. This means I can afford to be pretty strict.

1 P/E Should normally be below 25 and preferably above 12 or so. This is tricky with growth companies though so this rule should be taken under consideration later and maybe get removed.

2 Dividends. A profitable and well established company will pay dividends. High tech start up will not. I lost enough money on that before so will go the safer and less profitable route by picking companies to invest in that actually makes money. A company that gives all its profits might be nice in the short term but how will they finance expansion etc? Max dividend should be 70 % of the profits.

3 Growth rate PEG. PEG simply requires a stocks P/E value to match its annual growth in percent. A stock with P/E 20 should grow 20% per year to get a PEG of 1. A stock with P/E 10 that grows 20 % per year gets PEG 0.5 and a stock at P/E 20 that grows 10% per year gets a PEG of 2. A PEG between 0-1 is good.

4 Buy on positive reactions to the quarterly report, sell on negative reaction. Chances are the trend will continue.

There are  number of interesting trading strategies like Magic Formula, Graham, Net-nets & F-score. A combination of these with PEG and some additional filters might be a good way to go.

Net-Nets

This gave way too many positives and need additional filters

Piotroski F-Score

The Piotroski F-Score tries to identify companies that are potentially undervalued. Higher F-Scores classify a stock as a strong financial position, whereas low F-Scores classify a stock as likely to go bankrupt. 

Formula

The F Score is the sum of nine components related to profitability, leverage and operational efficiency. These nine components are each given a pass (1) or fail (0). The sum of these parts results in the F-Score. For each criteria that a company meets, it's F-Score is increased by 1.

Profitability Components

- Positive Net Income - 1

- Positive Operating Cash Flow - 1

- Higher ROA than Previous Period - 1

- CFO > NI - 1

Leverage Components

- Decline in Long Term Debt - 1

- Higher Current Ratio than Previous Period -1

- Less Dilution (# of Shares Outstanding) than Previous Period - 1

Operating Efficiency Components

- Higher Gross Margin than Previous Period

- Higher Asset Turnover than Previous Period

Graham

Adequate Size of Enterprise

Graham preferred large companies, he looked at stocks of firms that have become unpopular due to unsatisfactory developments of a temporary nature. When screening for company size, the three most popular criteria are market capitalization (number of shares outstanding times market price), sales and total assets. Graham focuses on sales for industrials and total assets for utilities because they directly reflect company activities and size, while market cap is tied to overall market levels.

Strong Financial Condition

As a test of short-term liquidity, Graham specified a current ratio (current assets divided by current liabilities) of 2.0 or higher for industrial firms. To measure the use of long-term debt, Graham required that long-term debt should not exceed net current assets or working capital for industrial firms. 

Earnings Stability

Graham liked to look at the historical company performance over an extended period of time. He prefers companies that avoid losses during recessionary periods. This points to industries such as utilities, insurance, food processing, medical supply firms and pharmaceuticals. Graham recommended 10 years of positive earnings in his screen for the defensive investors. 

Dividend Record

A common test for financial strength over time is a long period of uninterrupted dividends. The Graham screen looks for companies currently paying a dividend and that have done so over each of the last seven fiscal years.

Earnings Growth

Graham recommended a minimum increase of at least one-third in per-share earnings in the past 10 years, which translates into about a 3% annual growth rate—a rate that roughly keeps pace with inflation over the long term. Without such a criterion, a screen looking for companies with low multiples may list companies with poor prospects. 

Moderate Price-Earnings Ratio

Graham often averaged earnings over a period of several years. When defining the price-earnings filter, Graham required that the price to average earnings over the last three years be no more than 15. His goal in establishing the cut-off is to produce a portfolio with an average multiplier of 12 to 13.

Moderate Ratio of Price to Assets

Graham is a believer in using low the price-to-book-value ratio to select stocks and normally requires a ratio below 1.5 for the defensive investor. However, he also felt that a low price-earnings ratio could justify a higher price-to-book-value ratio. Therefore, he recommends that investors multiply the price-earnings ratio by the price-to-book value ratio.

Technical analysis

The technical analysis is trying to measure the flow of money going into and out of a company’s stock. I will try to use this to determine when it is time to buy and sell from my short list. Getting the parameters correct and decide on which methods to use will most likely be a continous work in progress.

1 Moving average

This is the easy one. The short moving average should be higher than the long moving average so it indicates that the stock is gaining strength. 5 + 34 + 200 days are recommended. Due to the relatively slow nature of this indicator it will lag behind the trend. It should still indicate the longer trends. Maybe it is good to have as a base filter but it might not pick up a reversing trend early on.

2 RSI

3 Stochastic

Buy when the indicator falls below the 20 line and then crosses above it again. Sell when the indicator rises above the 80 line and then falls below it again. This seems to be a pretty fast indicator that might be good for timing. I used to like it years ago, might need to study it in real life behaviour on stocks I own to evaluate it further.

4 Momentum

5 MACD

6 Parabolic SAR

This indicator might be a great help for me in setting the exit strategy. My plan is to start using it to set my stop loss levels. It will help me cut my losses short and also take home profits when the market reverses. Hopefully it will prevent me from getting married to my stocks.

7 ADX

8 PVI/NVI – Positive Volume Index/Negative Volume Index

Tries to measure what the smart (NVI) and uninformed money is doing. NVI indicates volume on low volume trading days and PVI volume on high trading days. Probably good for filter use.

9 OBV – On balance volume

On Balance Volume tries to measure the volume flow into or out of a stock. If it closes up all volume is considered up and if it closes down it will be considered down. Might be good to include in a composite indicator or screener as a filter. Rising trend = higher peaks.

10

Rules

1 Stop loss trigger at 90 % of purchase price. Rounded upwards. Stop loss sell price at 90% of price rounded downwards.

2 Same as above. Don’t repeat your mistakes, Stefan!!

3 Same as above. I really mean it this time so listen!

4 Stop loss will NEVER decrease.

5 Never invest against the trend. If times are troubled cash is also nice. No need to always be fully invested. Look at the trend channels, they tell a lot about the near future.

6 Wait for index to break through the downward trend channel before going back into the market. It is better to let it bottom out first.

Strategy tests

Hartvigson 1

PEG=0,1-1                 = Filter for “cheap” growth

F-Score and Graham over 10          = Filter for solid financials

Minervini to get the stocks currently in a positive trend. = Stock in positive trend

Stock above Parabolic SAR          = Trigger?