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June 04, 2011 - The Science of Making Money in Stocks - By Zacks Investment Research
By: Steve Reitmeister
Why do some people succeed spectacularly in the market while others fail?
The market is the same for one person as it is the next.
So why the big difference in performance between one person and another?
It all boils down two things:
1) Knowing what works, and, 2) Doing what works
While the stock market isn't a perfect science, the fact remains that if you concentrate on what works and stop doing what doesn't, you will most surely succeed in the market.
Knowledge Is Power
We've all heard the old adage, 'knowledge is power'.
It's a great saying because it's true.
And that saying couldn't be truer than when it comes to investing.
Take a look at your last big loser for example. After analyzing what went wrong, you soon discover some piece of information that – 'had you known that, you never would have gotten into it in the first place'.
I'm not talking about things that are unknowable, like surprise announcements that can catch even the most professional of professionals off guard. I'm talking about things that you could have known about or should have known about before you got in.
This is part of 'knowing what works'.
Did you know that roughly half of a stock's price movement can be attributed to the group that it's in?
Did you also know that often times a mediocre stock in a top performing group will outperform a 'great' stock in a poor performing group?
And did you know that the top 50% of Zacks Ranked Industries outperforms the bottom 50% by a factor of 4 to 1?
And did you also know that the top 10% of industries outperformed the most?
Was your last loser in one of the top industries or in one of the bottom industries?
If it was in one of the bottom industries, you should have known to not take a chance on something with a reduced probability of success.
That part is the 'doing what works'. (And not doing what doesn't work.)
That's not to say that stocks in crummy industries won't go up -- they do. And that's not to say that stocks in good industries won't go down -- because they do too.
But more stocks go up in the top industries, and more stocks go down in the bottom industries.
And that's part of the science of making money in stocks.
If you follow a set of proven profitable rules, you'll have a higher probability of succeeding.
Did You Know? . . .
Did you know that stocks with 'just' double-digit growth rates typically outperform stocks with triple-digit growth rates?
Did you also know that stocks with crazy high growth rates test nearly as poorly as those with the lowest growth rates?
Did your last loser have a spectacular growth rate?
If so, and it got crushed, would you have picked it if you knew that stocks with the highest growth rates have spotty track records?
Once again, this is the 'know what works' part.
It seems logical to think that the companies with the highest growth rates would do the best. But it doesn't always turn out to be the case.
One explanation for this is that sky high growth rates are unsustainable. And the moment a more normal (albeit still good) growth rate emerges, the stock gets a dose of reality as well.
Instead, I have found that comparing a stock to the median growth rate for its industry is the best way to find solid outperformers with a lesser chance to disappoint.
Now it's time to 'do what works'.
Did You Know? . . .
Did you know that adding a simple valuation metric can turn a good Price Momentum screen into a great one? That's what we did with our Big Money Zacks screen that was up 101.3% last year.
Did you know that by adding two additional filters to the Zacks #1 Rank stocks, it narrows that list down from 200+ stocks to a more manageable 5 stocks? That's what we did with our Filtered Zacks Rank 5 screen that has shown an average annual return of over 68.8% over the last 10 years.
Do you know what an R-Squared Growth rate is? What if you did? We have a screen that utilizes this seldom looked at item that was up 29.2% last year and was even up 14.2% in 2008's bear market while the S&P 500 was down -37%. That screen is aptly called the R-Squared EPS Growth screen.
Remember, you need to 'know what works' and also 'do what works'. That's the science of making money in stocks. And quite frankly, the science of success in everything.
Do you know how well your stock picking strategies have performed?
Whether good or bad – do you know why?
Do you know if your favorite item to look for is helping you or hurting you?
Get the answers to these questions and more. And discover what works and what doesn't before your next trade.
If you're determined to learn the secrets of how others make money in the stock market and how you can too, I encourage you to check out my new book, Finding #1 Stocks. Right from page one, you'll discover proven strategies and tactics to dramatically enhance your stock gains, including many that have never before been made public. I've poured my 20 years of investment experience and research into this book to show how anybody can become a better trader. I hope you give it a try.
Good Trading, Kevin
Zacks VP Kevin Matras is our fundamental and technical stock screening expert, having personally developed some of the most popular market-beating strategies at Zacks. And he's revealing all of his secrets in his new tell all book, Finding #1 Stocks: Screening, Backtesting, and Time-Proven Strategies.
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