Investing strategies are a way for each of us to actively participate in our financial future. Since the focus of this site is stock market investing, the following discussion will be limited to stocks, although bonds, commodities, real estate and other asset classes can be approached in a similar, systematic way.
A published strategy with explicit rules is a sensible starting point. In fact, unless you are a financial analyst, a rules based approach to investing is the only realistic one. A rules based approach also tends to eliminate emotions and behavioral bias. Neither is a plus for investing.
Technical analysis (TA) as a standalone approach is a topic covered in great detail on a number of worthwhile sites. For us, TA will only be considered as an enhancement to our fundamental investing style – primarily as momentum. We will focus on investing strategies based on fundamental analysis.
Fundamental investing styles include growth investing, value investing, and dividend (income) investing. There is generally quite a bit of rock throwing and “my way is better” talk in any discussion of style.
However, there is no single best investment strategy. There is agreement that you should not have all your eggs in one “style” basket. This means you will need more than one strategy.
It is a question of emphasis in the form of allocation. The consensus is that the closer to retirement you are, the more conservative you should be in your style allocation. This means a larger focus on value and dividend investing.
This is not because value and dividend investing have superior returns, but because they have less risk. In other words, you are less likely to have a large swing in your capital when you are more likely to need it.
Many of the strategies used to illustrate stock screening have both a value and a growth component.
From the discussion about market cap we know that stocks can be classified as micro cap, small cap, mid cap and large cap. In fact, there is even a nano cap class for really, really small companies. It is as important to have more than one “cap” basket as it is to have more than one “style” basket.
Investing performance benchmarks are baskets of stocks, usually in the form of a cap-weighted index. These benchmarks are often made up of stocks of similar market cap. For example, the widely recognized S&P 500 is a cap-weighted index representing 500 large cap US stocks. The point of having a benchmark is to compare apples to apples – a small cap strategy to a small cap benchmark, a large cap strategy to a large cap benchmark, etc.
One of the most overlooked aspects of choosing a stock investment strategy is the historical performance of the strategy. Knowing what has happened in the past is no guarantee that it will continue. But it does provide parameters to assess the current performance of the strategy. The historical performance of a strategy is most often assessed by back-testing. When possible, the historical performance of a benchmark is based on the actual price history of the benchmark.
Investing is a process and, like any process, can only be improved by taking a systematic approach that is repeatable and measurable. This is the real basis for stock screening. A measurable, repeatable process allows the performance of a strategy to be evaluated and compared against both expected performance and benchmark performance.
We present strategies to illustrate how stock screening works, not as investing advice. Our hope is that you will understand what is involved in selecting a stock investment strategy and take control of your own investing.
Where possible, investing strategies with published expectations based on back-testing are selected. Many of these are available in the published work of James O’Shaughnessy, Richard Tortoriello, and Wesley Gray.
In some cases, additional historical performance is available from other sources. For example, the American Association of Individual Investors (AAII) provides annual performance from 2001 on over 50 strategies including several by O’Shaughnessy.
We also try to choose sample strategies with published selection criteria. When the selection rules are specified, the strategy is said to be a white-box model or transparent. Transparent models free you from dependence on newsletters and proprietary models for stock selection. The AAII and the published work mentioned above are excellent sources of investing strategy models.
Currently the following strategies are included as examples along with “how to” instructions for implementing them in several popular stock screeners:
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