I have read many investment stratagies, but the two that have stuck with me are value and momentum. I choose both because they have been proven by academia and investment professionals to to return above average in the long run compared to buy hold in the S&P 500. Both strategies must be executed with consistency, conviction, and prudence. As I continued to read more books about these strategies, I refined my approach to be more rigorous. In addition, I used my software development skills to leverage automating repetitive tasks such as computing calculations and executing trades on a monthly basis.
With these strategies, I make investment decisions over a month by month basis and stay away from day trading. As thrilling as it may be, I believe day trading is probabilistically a losing game. One reason being that I lack the knowledge that people on Wall Street have, a decision I make day trading is a guess whereas some people on Wall street have more insight. I could get lucky and earn money one day, while another day I loose lots of money.
I trade as a retail outsider investor. I can earn money by being patient. For both investment strategies, I use the S&P 500 as the benchmark to determine if my investment strategies are doing well.
To mitigate, hindsight bias, I try to document my rational behind my investment decisions at the time I make the decision. If the result, doesn’t turn out as I had planned, I will understand the reason I made that decision in the past. Hopefully, I can try to prevent similar mistakes in the future.
Value Investing
My value investment strategy closely follows the approach described in the book Good Stocks Cheap. I built a tool that automates all the calculations presented in the book, and I store notes from my qualitative analysis from the questions asked from the book. With value, I begin by using a stock screener. From there, I used fundamental data to calculate the 5 year average Return on Capital Employed (ROCE) to look for companies that have consistent year over year high earnings and also calculate the debt / equity ratio to understand if the company is taking on too much debt. I use the Graham Number to determine if the present price of the company is a fair value. The Graham number is not a forecast it, but I use it as a barometer. I try to use the trust, but verify method to identifying if a company is a value company. I look at EV/EBIDA as another metric to verify that the company of value. Anything below 10 is good to me.
I try to look for companies that are in the deep value companies that are in the small cap range price between $5-$50. I want to earn at least twice with what I have invested. I look at companies that are at least 2x below the Graham number. For qualitative analysis, I read through the company’s annual report and answer questions using a modified Porters Five force analysis. The reason I choose to read the annual report over the latest quarterly report because the data reported is more audited closely by an external accounting firm.
Everybody knows about value investing, but I think value investing is difficult because one doesn’t know when the return will occur. One may invest in companies that are not in the news or have bad news. One must be patient and have conviction that the company they have invested is truly undervalued. When the price drops, because of their conviction, the person invests more.
Momentum Investing
Momentum investing is about taking a long position on stocks that are trending upward. I began my journey with momentum investing with Quantopian, which is no longer active. I dreamed for a long time to build my own trading algorithm . Eventually I did. I posted my algorithm on Github. I also created a website called Momentum Investment Gems to list the top momentum trending stocks within the S&P universe. I backtested my algorithm, which I will discuss in greater detail in a future blog post, using historical data starting in 2006 and ending 2021. If I started with $10,000, after 20 years of investing month over month I would have $300,000. I believe in my algorithm. Two sources that have been influential in my algorithm development using the Alpha Architect quantitative momentum philosophy and the stocks on the move book. I’m thankful to Andreas Clenow for writing the book Trading Evolved. The source code he posted was a starting point for me. I believe momentum is about long term consistency meaning month over month year over year and trust that it knows what it is doing.