Flexible Investment Strategies

Developing a trading system is not easy. It requires first of all good trading experience. Than you need to test your trading system under live trading conditions. It might take time as well as involve the risk of losing money. To overcome this difficulty in testing a trading system or a trading strategy, backtesting has been developed. Backtesting is possible with the use of software. A trading system might comprise of a set of two or more indicators with a set of rules that tell when to enter or exit the trade.

How to do backtesting? Backtesting uses historical data to test the performance of the trading system under the past market conditions. Using a backtesting software makes it very simple and easy.

There are many problems with historical data. There is no slippage in backtesting. Slippage is one of the most important problem that a trader faces while trading live. The other problem that the backtest ignores is the widening of spreads under volatile market conditions. So backtesting results are no guarantee that the trading system will perform well under live market conditions. Things that worked in the past might not work now. Similarly something that didn’t work in the past, may work now! You never know!

In other words, no two trades work out in exact the same way twice. SO you have to be careful when looking at the back testing results and take it with a pinch of salt. However, there are still some advantages of back testing a trading system.

Some markets are highly seasonal. For example, if you are a commodity trader and tend to trade agricultural commodities like the grain, seed or the livestock, these have a fixed planting and harvesting cycles.

For example, some markets especially the commodities market is highly seasonal and cyclical in nature. We can take the example of agricultural commodities like wheat, grains,corn, cotton, coffee and stuff like that. In case of the stock market, there is much talk of the January Effect. Well, it is there no doubt about it. Some years, it is highly pronounced and others it is not that pronounced. Similarly stock prices tend to rise at the end of each month and the first few days of the new months. The reason for this is that many institutional investors tend to put the new funds to work at the end of the month and the beginning of the new month! Now in other markets, you might not find any seasonal trends. For example, there is very little seasonality in curreny market or the bond market.

Back testing can also help you establish the amount of time a particular market tends to run in a certain direction. For example, in case of US Dollar Index, its trend lines tend to last for months to years.

Now when you back test your trading system and the set of indicators, you can check their accuracy. For example, if you using a trading system based on moving average crossovers, you can back test it using different combinations. Then monitor each combination under live conditions to see which works the best.

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Are you new to the Stock trading market? Are you just now thinking about opening a trading account or broker account? Or are you just looking to learn a little more about where your 401(k), IRA or mutual funds are being invested? Either way here is a beginner’s introduction to the Stock trading market.

Firms or individual companies often trade equity known as stock. The purchase of the stock on the stock trading market gives the purchaser a small percentage of ownership in that company or those companies that he or she chooses to invest in. Stock traders known as day traders often look to the stock trading market for short-term gains. Often times their investment time frames are measured in days and weeks rather than months or years. These are often times professionals who work on a full or part-time basis allowing themselves to hold full-time employment in other vocational arenas. However financial advisors or financial managers actually manage other individuals portfolios taking a commission based on trading activity in the stock trading market.

Then there are individuals or stock trading investors who look at the stock trading market as being a much longer-term investment. These individuals or companies hold their stocks for months or years at a time. In this instance the entity investing in the stock trading market has looked at a companies’ financial health on a fundamental level and feels that the long term prognosis for that particular company is positive.

So ultimately while some individuals are taking a long-term position within the stock trading market other individuals choose to take a much shorter term position pulling their earnings off the table on a much more frequent basis. Either method of trading can make money however an individual who’s completely unfamiliar with the market should seek the advice of a financial advisor in order to prevent the risk of lost capital.

So always keep in mind whether you’re getting in to the stock trading market as a long-term investment or for short-term gains, you can make money in a bear market and in a bull market but if you get greedy ultimately you will lose.

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There are simple as well as complex candlestick patterns that are used by traders to identify trend reversal as well as trend continuation. Candlestick charting has become one of the most important tool in the trading arsenal of any trader. Almost all the trading platforms now have candlestick charts in their menu. One candlestick pattern does not occur frequently but when it does it means that the trend will reverse itself soon is the Inverted Hammer.

Now an inverted hammer can get formed in a downtrend as well as an uptrend. In a downtrend, the first day is a bearish candle signalling that the bears are still in control of the market. An Inverted Hammer is a quite rare pattern as the price action needed to produce it does not takes place frequently. But if it does, it is an important signal that you shouldn’t ignore.

An inverted hammer has a very small body at the bottom with a long wick at the top. As the high is way above the body, most of the trading took place near the small area close to the low. This low serves as the support for the upcoming days.

Now, you should wait for the confirmation the following day in order to trade this bullish inverted hammer pattern. If the open of the next day after the appearance of the inverted hammer pattern is higher than the low of the previous day, the inverted hammer pattern is a true pattern and you can trade it by putting the stop at the same level of the open of the day.

Now, when an inverted hammer is formed in an uptrend, it means that the uptrend is about to reverse itself into a downtrend. On the first day, you will find the usual bullish candle signalling that the bulls are in control of the market. This is followed by a gap opening and more buying.

When you idenfity a bearish inverted hammer pattern, you can safely go short by putting a stop near the open of the signal day or the day when inverted hammer was formed. Soon the bears start to take control of the market and push the prices down. The close of the day is equal to or close to the low of the day.

Once, you have placed the stop, you have limited your risk. In case, the market moves in the direction as anticipated, you make a nice profit. Placing a stop loss is very important in trading risk management. If the subsequent price movements do not confirm the inverted hammer, the stop loss comes into action and takes you out of the market at an acceptable loss. If you are an aggressive trader, you can place the stop loss close to the high of the inverted hammer.

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Timing

This Stock Market Guide explains the basics of Market Timing and other simple Market Analysis.

Let us first take common stocks. Consider both the earnings and the dividends as they relate to the price. Check the historical trading pattern of the shares concerned. This will give you a clue as to whether the stock has been a volatile performer and whether it has fluctuated with cyclical trends in the economy and the stock market.

One of the most important economic indicators is the bank prime rate — the rate of interest at which commercial banks lend money to their best customers. This interest rate is a good indicator of the general level of interest rates, since most other rates rise and fall with it.

You should seek to determine whether interest rates are likely to rise or fall in the near future. The financial press frequently discusses these matters. Often in the past, stock and bond prices have generally fallen when interest rates rose. As a result, if you expect a rise in interest rates, you should consider keeping your funds liquid. On the other hand, if you expect that interest rates will fall, you should consider investing in stocks and bonds as interest rates start to drop.

Price-earnings ratios

 For stocks, the price-earnings ratio and the dividend yield are important indicators. The price-earnings ratio, or earnings multiple, as it is sometimes called, is the ratio of the price of a company’s stock to the annual earnings per share. The P/E is simple to calculate: Divide a company’s annual earnings per share into the prevailing price of one share of the stock. If ABC Corp. had profits of $2 per outstanding share in its latest full fiscal year and its shares are trading at $18, then ABC would have a P/E of 9. If the stock was selling at $50, its P/E would be 25.

What does a P/E mean and what does it indicate? When you buy a stock, you buy a piece of the company and its profit potential. Thus, the greater the potential for growth, the higher the potential value of its shares. A P/E of 10 indicates that the market is willing to pay the equivalent of 10 years’ profits for the stock. At 20 times earnings, the market has put a much more optimistic and thus more expensive value on the shares. A stock with a low P/E is often considered to be low growth, or mature, and a stock with a high multiple is considered to have high potential.

Price-earnings ratios are also a good guide to risk. A stock with a low P/E may not have much growth potential, but it is a lot less vulnerable to a sharp drop in price than a high flyer. Nothing drops as fast as a stock whose profit growth does not live up to the market’s optimistic expectations. As the sad truth finally dawns on investors, the stock price will drop back to a level justified by the more modest earnings.

Most financial and daily newspapers provide regular information on P/E and average dividend yields. Before you buy any security, you should always check its P/E in relation to its growth potential and compare it with other comparable stocks and to the broad market indexes.

Changes in price-earnings ratios

The price of any stock reflects two dynamic forces: its profit potential and the value the market puts on this potential.

Stock prices often begin to rise before profits begin to grow because the markets “expect” that profits will increase. Thus, investors are willing to pay a higher P/E multiple for the shares. On the other hand, rising profits are no guarantee that the stock price will continue to move up. If the rate of profit growth is not up to the market’s ex­pectations, then the market will, in effect, place a lower P/E multiple on the issue and the price will drop. This is termed a multiple correction.

The phenomenon of the multiple correction has trapped many small investors in the stock market. The trap works something like this: The investor buys a high multiple stock on rumors that profits are likely to continue rising. But not knowing how to interpret the high multiple, the investor fails to bail out in time when growth rates are dampened by, say, anti-inflationary monetary policies.

The perfect situation is a sleeper stock with an unsuspected earnings potential and a low multiple. The odds are that its stock price will rise much faster than its profits once investors discover its new horizons. Their buying will push up the P/E multiple.

Now, what is a low multiple and what is considered a high multiple: Historically, the average P/E of stocks covered in the Standard & Poor’s Composite Index ranges from about 5 to 25 times average annual earnings. There is a wide variance within various industrial groups and within the other major groups. High-technology stocks often trade as much as 50 times their earnings per share or more, while bank stocks have traded at 4 to 15 times earnings.

The higher P/E for high-tech stocks indicates the speculative expectation that data processing demands, micro-circuitry development and the accelerating use of computer hardware and software will create rapid and substantial growth in the profits of these companies.

The low P/E for bank stocks reflects the market’s view that this industry’s growth is slowing and that investors expect no immediate improvement. However, it could also indicate an overlooked stock or perhaps a temporarily out-of-favor one.

Dividend yield

The dividend yield is very simple: Divide the annual dividend rate by the market price for the stock. A 50 cents dividend on a $10 stock works out to a 5 percent yield.

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