So let’s answer the questions above, quickly, with a broad paint brush.
If I want to shoot for a 20% return, I will have to stick to growth stocks. Buying Telstra for the dividend only with no earnings growth in sight is NOT going to achieve my investment objective.
I will often have to find medium sized companies in new industries that can manage growth earnings by at least 20% p.a.
But picking the right company is only part of the story; you should also try to get the timing right…because as in finance, time is money.
I suggest not buying stocks in a downtrend (trying to catch a falling knife…), but wait until the stock is in a confirmed uptrend.
Using longer term moving averages is quite useful. The best time to buy a growth stock is when it finds support on a rising long term moving average and bounces off support or when it breaks out of a prior trading range on above average volume.
Then, and ONLY then can we buy a certain stock.
Before we buy we acknowledge that our investment thesis or our timing may be wrong and the stock could go down in value.
As such, we set a mental stop loss and sell – in a disciplined, not ‘questions asked’ way – if this stop loss level is reached. I would sell a stock if it drops below 4% to 10% of the purchase price and you can try another investment with the remaining funds.
If you are not losing money you must be making money and now comes the hardest part in investing: How to take profits.
You could take smaller profits more often, for example sell once you have reached a predetermined profit target such as 20%.
If you do this you will sometimes regret getting out of a good investment too early.
You could alternatively let the profits run until the medium to longer term trend reverses, for example if a trailing stop is triggered or the stock trades below a flattening long term moving average.
This strategy will keep you in trades often much longer for greater profits, but you tie up your capital for longer periods and by definition always get out too late.
Only liars get out at the exact top.
Combining small losses with larger profits will give you positive statistical expectancy, something like winning $2 on a coin flip when heads come up and losing $1 if tails come up.
You just have to repeat often enough and you are guaranteed to make money over the medium term with a cluster of losing trades pretty much guaranteed occasionally.
Once you are out of a profitable or losing trade you can re-enter if the stock still meets your previous selection criteria (earnings growth) and you find a technical sweet spot to enter as previously discussed.
As a winning trader, you do not average down (throw good money after bad), but you average up (pyramid), buy more shares if your previous position is profitable and another entry signal is triggered.
You don’t want to make the pyramid top heavy but buy incrementally less shares with every addition.
Most investors only invest in the big companies they know (CBA, Telstra and Woolworth are the usual suspects for Australian mum and dad investors) and they tend to have a home bias of only investing in domestic shares.
Given that Australia is only 2% of world market capitalisation, it does not make sense ignoring the remaining 98%.
I tend to invest in US stocks (about 50% of world market cap) as they have sectors we simply don’t have in Australia (FANGs, software, chip makers, biotech etc).
In order to follow the rules, first you have to have clear cut rules and they should be written down making it easier to follow.