24th November 2011
Mindful Money considers an array of techniques the average investor might use in their pursuit of profit.
For those who have discovered the thrill of playing the stock market, it is a roller-coaster ride. But while a random choice of stocks may produce as good a result as any fund manager, there are strategies we can use for finding those that might outperform – or at least avoid the bad ones.
One warning – there is no one way to pick stocks. Better to think of every stock strategy as nothing more than an application of a theory. As well as this, take into consideration how well a strategy fits your personal outlook, time frame, risk tolerance, and the amount of time you want to devote to investing and picking stocks.
Follow a leader
There are a multitude of example stock portfolios if you want to go it alone available online. For example, here is one from The Motley Fool.
Alternatively, go straight to the gurus, and follow them. Here is Buffett, taken from Ruminations on Risk:
"Take the probability of loss times the amount of possible loss from the probability of gain times the amount of possible gain. That is what we're trying to do. It's imperfect, but that's what it's all about."
While we may not fully grasp his system, here Marketwatch says: "As I wrote last week in an article on Warren Buffett's recent acquisitions, you should never mindlessly ape the trading moves of another investor. But studying the moves of successful investors can be an effective way to step back and get a little perspective on your own trades."
The media often reports the sector or stock Warren Buffet holds in his portfolio, recently stating that he favours Japan as a buying opportunity despite it being hit by a series of natural disasters.
Use a probabilistic exercise – and there are plenty of them. One is what this article calls the "Babe Ruth Effect"…"the frequency of correctness does not matter; it is the magnitude of correctness that matters". Say that you own four stocks, and that three of the stocks go down a bit but the fourth rises substantially. The portfolio will perform well even as the majority of the stocks decline, says Psy-Fi blog.
"Building a portfolio that can deliver superior performance requires that you evaluate each investment using expected value analysis. What is striking is that the leading thinkers across varied fields-including horse betting, casino gambling, and investing-all emphasize the same point. We call it the Babe Ruth effect: even though Ruth struck out a lot, he was one of baseball's greatest hitters."