In this post, I’d like to share some of the home brew trading techniques that I’ve developed since 2009. Of course, this post should not be relied upon as investment advice, and all trading techniques are used at your own risk. These techniques just happen to have worked for me and may or may not work for you. Mixed Money Arts is not responsible for any losses incurred as a result of my trading strategies.
Okay, now onto the good stuff.
Selecting a Brokerage Account
First, you’ll need a brokerage account in order to buy or sell stocks. I’ve used both OptionsHouse and TradeKing (referral link) which offer a pretty low price of $4.95 per trade. If you use my TradeKing referral, we both get $50 if you fund $3,000 and make three trades within 90 days of account opening.
When choosing stocks, I ask myself several questions. Which markets or industries do I understand? Which companies do I like? Do I like said companies’ business models?
No matter how profitable a company or how popular, I caution myself from investing in companies in unfamiliar territories (e.g., foreign stocks), companies that I’m not into (e.g., women’s shoes) or companies with unproven business models (e.g., emerging growth companies that have no revenue yet). Much of this is personal preference and a reflection of my risk tolerance.
Financial Statement Analysis
Next, I look at the company’s financial statements with Google Finance, starting with the income statement. Below is a sample screenshot:
Here, I’m looking at annual, not quarterly, data to see how the company has done year over year. Has net income (profit) increased or decreased? How about revenues?
On the balance sheet, I look to see how much long term debt the company has. Are there enough cash and cash equivalents to pay off at least half of that long term debt?
Finally, I look at the company’s return on equity (ROE) and price/earnings (P/E) ratio. The higher the ROE and lower the P/E ratio the better. I usually pick companies that have an ROE of at least 30% and a P/E of less than 30. You can screen stocks for a preferred set of metrics with Google Stock Screener.
Buying and Selling at the Right Time
Now that I’ve chosen my stocks, I need to buy them at the right time. This part is not that different from shopping for an iPad. You’ve decided you want an iPad, but you don’t want to buy it until it’s on sale. Like buying an iPad on sale, I like to buy my stocks ‘on sale.’
For this, I use StockCharts.com to see when a stock is relatively low or high compared with prior periods. When I enter a company’s name or stock symbol, I end up with a screen like this:
Using the drop down menus under ‘Overlays’ and ‘Indicators’, I select ‘Bollinger Bands’ and ‘Slow Stochastics’ and click ‘Update’:
Now I have a chart like this:
The candlesticks that you see represent the price of the stock. I like buying when these candlesticks hit the bottom Bollinger (purple) Band and selling when the candlesticks hit the top Bollinger Band. For our example stock above, good buy periods might have been November 9-16 and January 1-19. Good sell periods might have been October 1-12, October 20, November 23-30, December 19, etc.
Similarly, I like buying stocks when the Stochastic Oscillator (top line graph) hits 20 and selling stocks when the Stochastic Oscillator hits 80. For our example, good buy periods might have been November 6-18 and January 1-15. Good sell periods might have been October 1-26, November 30-December 8, December 16, December 19-22, etc.
For me, it’s optimal to buy when both the Bollinger Bands and Stochastic Oscillator are signalling a buy. These periods are November 9-16 and January 1-15. Likewise, it’s optimal for me to sell when both the Bollinger Bands and Stochastic Oscillator are signalling a sell. These periods are October 1-12, October 20, November 30, etc.
In summary, I start by choosing stocks based on what I know and like. Then I look at the financial statements of the companies I’ve chosen. Once I’ve selected companies with strong financials, I look for the appropriate time to buy and sell by looking at charts that measure the stock’s performance. If you’re interested in more techniques, I recommend reading books like Buffettology: The Previously Unexplained Techniques That Have Made Warren Buffett The Worlds or The Intelligent Investor: The Definitive Book on Value Investing.*
Update: Over the years, I’ve slowly transitioned myself away from stock trading and now primarily invest in index funds.
*Note that if you decide to buy through the links on this page, I’ll get a small referral commission from Amazon.