How to buy stock - searching for patterns

So now lets get down to the nitty gritty, of how I found a stock and index trading system.

A systme that can be demonstrated would not only have produced the return on that graph - but would have made continuous gains for the last 20 years.

Moreover the method I am about to describe can find other trading schemes too.

The first key issue it is important to understand is simply a way of thinking.

Now the scheme that produced that graph, has NOTHING to do with moving averages or any conventional indicator system: but a moving average system will do wonders for illustrating the point I have in mind.

PROGRAMMING IS NOT THE ANSWER

Historically what people do: is write a program to test a system.

If their idea is buy when average1 crosses average2 and sell when average2 crosses back the other way. That is simple isnt it?

Theres only two possibilities - if A is greater than B or B is greater than A. Simple to say and simple to test in one case you are long, the other short or out of the market
Sadly of course if fails every time - nothing that simple works.

So then you decide that may be it will work if I only buy is not only if A is greater than B, but also the gradient of A and B are both above zero, that is they are both increasing.

So then your purchase criterion depends not on one thing - but that 7 possibilities - thats
A is the 5 day moving average lets say
B is the 12 day moving average maybe
Here are the possibilites

gradient A> 0 Gradient B>0 A>B
1 yes yes yes
2 yes yes no
3 yes no yes
4 yes no no
5 no yes yes
6 no yes no
7 no no yes
8 no no no

One of those 8 conditions is used as a buying signal, another one to sell, one to go short and one to buy back.

It isnt obvious which should be used. So there is lots to test and change in the program, as well as changing the average durations.

Reality is nothing as simple as that works either

But there are already a LOT of combinations of possible buying and selling criteria to chose.

It would take many hours to do a rigorous test - when stop loss criteria and trading costs are also included.

ANY TESTER WILL TELL YOU IT QUICKLY GETS OUT OF HAND!!

Then you decide that it is actually the stock price that matters..

So it is when the stock price rises above both of the averages , and both of the gradients are positive.

So then the number of possibilites are already 16 for buy or sell.
And the number of permutations is huge.

The more factors you put in , the more the testing gets out of hand.

And then of course you want to include - whether or not the stock opens higher than yesterdays center of trading.

And eventually you have too many possibilities to test
Too many to test using software changes.

THE ANSWER IS TO THINK IN A COMPLETELY DIFFERENT WAY

And now my military signal processing background kicked in.

The truth is computers are not the best things to find patterns.
The human eye and the human mind are far more powerful.

So what most military systems do, is not take the decisions , instead it presents the information to the human in a way that it is easy for the human eye to take over.

So let us go back to that example again.

If there are 8 different possibilites for buy signal, and 8 possibilities for selling lets say, then there are 64 possibilites total for trading schemes.

Now lets introduce the concept of SCATTER - it is scatter that has found all my trading schemes.

So now consider you have 64 bins.
Each bin is what is called a scatter graph. You put a spot or a cross or a tick, for each time that condition was triggered: at a height on the graph according to how much it won or lost.

Then you let the eye take over . Most of the bins have random spots. Just one or two bins have a cluster of spots of mostly wins or mostly losses. The eye tells you whether there is a pattern or not.

And in this way you can test 64 trading possibilities all at the same time.

It is these scatters which I have used todecide how to buy stock

As clear as mud? Probably!
In the next post I will give you a simple example.
If you are interested in this, please stumble or digg it, or click it to netscape!!!

That way I will decide whether to continue!

How to buy stock - A story of a discovery

When I started to invest, I probably did what most people do:

I read. I listened. They were speaking in riddles. About support and resistance, profit taking, worries about interest rates. Everyone seemed to have an explanation for everything. I looked at the tips on forums and followed respected writers views.

And I lost money hand over fist.

Sure there seemed to be explanations. But none of them seemed to be work.
So thats when I started to get wise. I stopped investing

And I started to test.

Surely there was someone out there, who knew how to buy stocks. I figured.
It was a matter of sorting through ideas to find the wheat from the chaff.

Now I had tested O higgins system - the dogs of the dow, I referred in the previous post.
And sure If you were patient it seemed to me you could be reasonably confident of beating the index as a long term investor.

But I was impatient! I wanted a system that worked quicker.

So I went through all of the standard and respected texts. And got more and more depressed.
I got to be good at backtesting stock ideas - and proving none of them work. Not over the long term, and not in the simple forms presented.

If you have any doubts on this, go test one of those moving average crossing systems that appear in the chartist books. See how much money you LOSE!!! -

It just is not that simple, and I am convinced that much of that stuff is repeated from book to book, by people that never tried it. All the spreadbetting companies are happy to show you that technical analysis, it helps you to leave more money with them.

So then I decided to get clever. I had spent my earlycareer using complex maths to look for tiny signals hidden in massive noise in hush hush military systems. So I started to apply a few simple ideas for looking for patterns..and then!!!!!

And then I tripped over a secret........The answer was far simpler than I ever thought it could be.
In fact when I discovered it, I spent at least a week, looking for the error I had made. I just didnt believe it could be that simple.

Thats the simple trading idea that produced the graph above for the FTSE.
I would like you to look at just two things.

First,

It really does massively out perform the FTSE

Second, there is not the massive leverage in most of these dishonest trading schemes - in fact the risk on any trade is only ever 5% of capital before we pull the trade.

The final observation - where are the bad years?
Most of the losses occured at times when we were out of the market and a stop loss straegy caught many of the others

And this isnt some overtuned indicator scheme, that only works on paper.
In fact - the scheme contains no maths at all - so it cannot be overcooked.

And before you do the sums - that is showing 200% per year.
I am NOT promising you will do that. What I am saying is when you understand the reason, and look through the history you will be confident that there must be something in this.

In the next post - how I searched for the needle in the haystack and where that graph came from!

How to buy stock - a system based on fundamentals

So now lets look at how to buy stock using a system based on fundamentals.
And as we have said - we want a system that uses simple rules that can be tested.
And a system that at beats the index.

Clearly such a system will not make you warren buffet!
No mechanical system can ever be substitute for the intuition of a master reader of markets.

On the other hand we have already said so: most investment managers never manage to beat the index over any period of time

And another statistic is that most day traders and spreadbetters, not only fail to win - they lose.

So if we have a system of how to buy stocks that set modest goals of just beating the index then we have already done better than almost everyone in the market.

Just be patient, we will show you how to do even better than that.

How to buy stock based on fundamentals

If you have ever tried to study fundamentals?
That is liquidity, profit, assets and yields - products and markets and managements.

You will know that it is not easy to know how to buy stock using fundamentals alone.

It really is a minefield.

Here are some obvious facts about fundamentals.
Lets explain first of all- what is any investment there to do? And the answer is to earn money that goes back to the investor! Never forget this!

• You will see that share prices all well outstrip the assets of the companies - in most cases massively so - so you are not getting value for money in terms of the assets underlying your shares!

• The next obvious fact is that if you try to base the value of a company on such things as price earnings. Then with the exception of a handful of utility companies you dont seem to get much of a return on your investment at all.

• The final obvious fact is that massive income jumps and massive share price increase is always the preserve of small companies -so rewards are concentrated at the riskier end!- which are equally prone to nose dive!

And when you look at all this you realise the magical touch that Warren Buffet has - he is not investing on present worth, present income or three year projections. He looks at long term value. Now there are ways such as the harvard model to analyse business merit. Which can sort some of the wheat from the chaff. But picking winners is a little like going to the races...

So is all lost? Can we find a method of how to buy stocks to prove that it can be done.
The answer is a resounding YES! and the resounding yes comes from an odd conclusion.

It comes from the fact that the stock market, which should be an efficient market - is not efficient at all.

What is an efficient market you ask?

The idea is that in an efficient market everything that is known about a stock is reflected in the value. because if there was information that should affect the share price, the price would move to absorb the information. So that the idea of a share being over or under valued in terms of present price should NOT in an efficient market exist.

The reality is Efficient markets do not exist.

The reality is that few if any have the foresight of Warren Buffet, and more importantly stocks go in and out of favour so that immediate price certainly does not always reflect a fair price.

And we will prove that with a set of simple rules.

So what is the question that is vital in how to buy stocks - what is the essential fact that gives any stock value?

The answer is not just profit - it is profit distributed to shareholders - and that means dividends. For as long as a company is paying dividends its stock has value in an absolute sense -

• Sowe cannot go far wrong if we take the dow index and select the ten highest yield shares - that is dividend as a proportion of price. And that is the first part of the system!

Then from these pick the stocks that are out of favour. The way to judge this is from the share price. Share prices go from cents to a few dollars, and after sustained growth to hundreds or thousands .

If the price ever gets to be too high to make trading easy, there is generally a share split that ensures share prices tend to be a few dollars a share.

So what happens in a bad year when a stock goes out of favour? the stock falls dramatically and can go below a dollar. So the outward sign of a poor performing share, is one whose price is low!

• So the second part of the system says pick the five lowest price of the ten highest yielding shares.

And it is as simple as this. Buy those shares. Hold them for a year. Then repeat the calculation.

And has worked ! Boy has it worked!

Over a period of 20 years and depending upon exact details - this scheme has returned approaching 20% over the long term which is massively more than the index

And massively more than most managed funds. Now this is not my idea it is well established and can be found in Higgins celebrated book which can be found HERE And it contains many other observations and refinements.

Jim Slater has also published books in the UK that test a similar process on the FTSE and that has worked over long periods too!

So what does this tell us about how to buy stocks?
It tells us you can beat the index
It tells us you can use a system to do it.
And if you do that you are beating most of the professional fund investors.

But most of all it tells you

Rule 3 of how to buy stocks - the market is not efficient - there are value differences And they can be exploited.

SO is that all we have to say?

Absolutely not - we havent even started yet - there are systems that dwarf these results. Be patient - we will explain - keep reading , and please? subscribe to my feed! I would like to know whether my readers are finding this interesting and whether to keep it up!

How to buy stocks - fundamental investment for a marketing genius

Before I can get on to some exciting stuff, I need to cover a bit of background.

So there are two essential camps of investors - there are those who study patterns in stock and instrument prices - and use the patterns to determine buying decisions .

Now in later posts we will show you some patterns that will blow you away - you wont find them in any book . So be patient we need to cover some background first.

People who make decisions on how to buy stocks based on patterns in prices are generally know as "chartists" – they talk of price action and technical analysis., of break outs, price ranges and indicators – and then theres a whole new category of patterns that I will show you!soon...

Then there are fundamental investors who look at the underlying company instead.

They are interested in profits, growth,assets, liquidity, markets , competition and market share. Most professional investment funds, base their decisions on fundamentals

Remember the warning. Most professional investment funds don’t do any better than the index. So they are sticking pins in with your money - and charging you for the privelege of doing WORSE than a monkey throwing darts at a dartboard.

Of course success is possible at fundamental investment

Warren Buffet – is the man who knows how to buy stocks based on fundamentals.

Warren buffet is proof that it can be done. The performance of his Berkshire Hathaway fund has been nothing short of staggering.

For long periods he exceeded 40% growth per annum a man with a true midas touch who is now the richest investor on the planet.

Buffets method of how to buy stock is to base decisions on his assessment of the potential of a company to become a massive brand - not now, but over the next ten years.

He searches which markets will grow massively and identify players in those markets who have what it takes to achieve massive growth in their sectors both on a large and smaller scale.

There have been many good books on warren buffet and his methods, so there is little point in reproducing thosw ideas here so we suggest the interested reader who would like to know more about buffet would do well to read this

Warren buffet is unquestionably a marketing genius. He sees the things that many do not. And thereby hangs the problem – you CANNOT reduce buffets methods to a simple set of rules.

What you want is a system on how to buy stock that is "Look for this, select these – check this and so on."

And that poses the problem – can the average investor discover how to buy stock like buffet ?– Whilst some have achieved success on more moderate scale, the general answer must be no!

So let us produce our rule number two

Rule 2 of how to buy stocks – find a system that can be reduced to a set of rules.

There are two massive reasons for this – first it is difficult to follow a system that has no rules and second is rule 1 – do not invest in what you cannot test – and if there are no rules, then how can you test your rules work on how to buy stock?

So does that mean fundamental investing is out? Absolutely not .

In the next post we will show a system for fundamental investing that has stood the test of time!

And in doing so we will push back the benchmark for what makes a good a system for how to buy stocks

If you want to know how to buy stock - I have a warning and an opportunity

The first thing to consider about how to buy stock, is what constitutes success.

Did you know that MOST managed equity funds run by professional managers underperform the stock index. And by most that means well over 90%- so the question you have to ask - is do the professionals know how to buy stock?

The benchmark of how to buy stock - can you beat the index?

And it also begs another question. If you cannot do consistently better than the index, then should you buy stock at all, or buy an index linked fund?

Well there is news both good and bad.

The bad news is that most of what is written on stock trading systems does not work
I will repeat that it is important - MOST of what you read in books does NOT WORK - later on I will illustrate this with concrete examples. I will show you on a verified spreadsheet that you know all of that stuff about crossing averages and moving average indicators. FORGET IT
SImple backtesting proves that it is an assumption repeated so often it has gained the status of fact.

The good news

The good news is there are methods and systems which do work! And in later posts I will show you a concrete example, to prove that you can beat the index - and do it consistently. And that will springboard a set of ideas which have been shown to work well.

The key to all of this , is when you have found a method that you think will work.
Before you buy stock, DONT. Test the system, back test over long periods. Make sure that it works. Then paper trade. And only when you are sure, back your method with money.

Warren Buffet is probably the most consistent investor of all time.

Do you know his first rule of investing? NEVER LOSE MONEY!

So in the next post I will show a system which has consistently beaten the index

How to buy stock rule 1? - Test. test and test again before you ever back ideas with money

How to buy stock - so many issues

A site dedicated to experience knowledge and comment on the fascinating world of how to buy stock.

How to buy stock has many aspects.

How to choose stocks...

• fundamentals? - thats looking at underlying performance
• charting? - looking for patterns that imply future price movement
• scalping? - riding a short term trend
• timing? - picking events in the companies year that herald movements in price
• price action? - price break outs from current changes

We will tackle how to buy stock on each of those methods.

How to buy stock also begs questions of what mechanism to use:

• spreadbetting - which allows shorting - and fast market entry and close
• nominee purchase - avoiding the need for certificates
• certificated purchase - if you wish to attend company meetings
• options - if you wish to back a movement one way only
• betting exchanges allow a fixed risk

How to buy stock also involves questions of risk!

• how much of a portfolio shoulf be dedicated to one share
• how is that proportion affected by leveraged or margined trading?
• is hedging viable or valuable to defend against index movements

And finally how to buy stock also means when to buy stock

• Once some basics are covered we will reveal here some fascinating information about movements in stock
• Had you known about timing you would have made a profit in all of the bear years after the last big dotcom crash

Please note this site does not advise on stock purchase or sale. This is information to be used for interest only to allow the author to share his fascination for stock price movements.

And what the author has discovered over many years on how to buy stock.