There are plenty of common strategies for investing well. However, there are also many which, despite being much less commonly known, can be extremely effective, so effective that once you see their benefits, you may rely on them to boost your investing results for years maybe even decades! These are not gimmicks, they are tried and true methods, which have been proven over the test of time.
1. Strength Is Relative
The relative strength index (RSI) is a measure of how overbought (or oversold) stock is at a certain point. Don't worry about all the complexity or details, the relative strength index will be calculated for you through any standard charting service (so it is not necessary for you to do all the math to work out the final number)!
By taking the most recent 14 trading days, then dividing the average gains for the stock on "up" days, by the average loss on "down" days, you should have a value between 0 and 100. Typical interpretation is that any stock with a current RSI of less than 30 is "oversold," while any value above 70 means the shares are "overbought."
As a momentum indicator, the theory is that overbought stocks are being pushed to very high levels, and thus may be due to drop back down as the typical buying patterns normalize. In the case of oversold stocks, the RSI is suggesting that the shares are most likely to rise in the coming days.
While no technical analysis indicator should ever be relied upon exclusively, the relative strength index can often provide insights into the next direction of the share price with greater accuracy than almost all other signals. In addition, by combining the RSI with other technical signals, it can help add additional clarity (and therefore accuracy) to your investment decisions.
Consider a stock you own which you are thinking about selling. If the relative strength index is at 85, then it may be a good time to unload the shares. If the RSI value is coming in at a low 25, then maybe you would consider holding a while longer, since the shares will most likely increase from their current levels.
The charts below illustrate BP's closing share prices from January to May of 2011, and BP's 14-day relative strength index from January to May of 2011.
2. Average Which Way
You have almost certainly heard of averaging down. If not, the concept simply refers to buying more shares of a stock you purchased previously, and which have declined in value.
For example, you bought your favorite penny stock at $2.45... but then the shares slumped towards $1.70. If you buy more of the same stock at this new lower price, your average price paid per share would be much lower.
In our example, you would have acquired part of your holdings at a higher price, then more at the lower price as well. The average price you have paid would fall somewhere in between the two levels, depending on how many you purchased at each price point.
While a common practice among less-experienced investors, especially those who have, until this point, picked a "losing investment," it is a very ineffective one. Unfortunately, in most cases, it is just a way of throwing good money after bad as the shares most often continue their downward slide.
It can work out sometimes, but math and history both suggest that it is a losing approach in the majority of cases. What turns out to be much more effective is the act of "averaging up." When an investor buys a stock they like, and then those shares prove the individual right by increasing in price, it often makes a lot of sense to buy even more. Shares on the rise are most likely to continue on the exact same path, pushing further into higher territory.
By averaging up, the individual has invested more into what, so far, has been working. They made the right call in the first place, and by putting even more funds into the winning stock, history and math both suggest that it will be a winning approach.
3. Stomp Out Downside Moves
Especially with volatile and speculative shares, it is always a good idea to limit your downside risk and exposure. The great news is that this can be easy to do; by using stop-loss limits, you can protect yourself from any significant downside moves. This simply involves having a "trigger price" slightly below the price at which you first bought the shares, and then selling immediately if the investment drops to that level for any reason.
For example, you purchase the stock at $4.50. Then, you could set a stop loss, or trigger price, at $4.20. Then, if the shares drop to that level at any point, you instantly sell the investment, no questions asked.
Most brokers will allow you to set an automatic stop loss once you buy. That way you don't even need to keep an eye on the shares, knowing that if they begin to decline you sell order instantly goes live, and the investment is sold. Often, this will keep you from seeing any larger losses. Even when and if the shares keep tumbling, your total loss would be limited to 30 cents per share, in our example above.
Setting a good stop loss trigger price can be difficult in some cases, and each specific stock and situation will call for unique details. Depending on the volatility of the underlying shares, in some cases, it may work and be appropriate to place your trigger price just 3% below your original purchase, while in other situations you would be better served to aim even lower, such as 20% beneath your original buy level.
Keep in mind also, that the consideration with stop-loss orders is that you can potentially get "stopped out." In our original example, consider a scenario where the shares dipped all the way to $4.15, before reversing much higher towards $8! Your stop loss price would get triggered right when the share slipped past $4.20, and you sell for a loss of 30 cents per share. Then, you can only watch (and perhaps even cry), as the investment next climbs towards significantly higher levels.
That is what makes it so important to set effective trigger prices. Always remember that every stock has its own natural volatility, and if you set your stop loss price too close to the current price, then the natural moves of the shares can take out your investment.
What might make more sense in the example above, would be to choose a trigger price which is at least 10% below your purchase, or maybe even 15% or even more. You will still be protected from significant downside and will be much less likely to get stopped out.
Another useful consideration, especially if you are trading speculative, volatile, and/or thinly-traded penny stocks, would be to use support levels to help you decide on the perfect trigger price. For example, if the shares have a very solid support level at $2, you may be able to get away with placing your stop loss at $1.98 or so. The only way you get stopped out is if the investment drops through that support level (which is typically less likely than if there was no support level at all). This increases the odds of the shares maintaining their current level (or better) while decreasing the chances of the shares falling (and thus triggering your stop price).
4. Sneaky Insights
Drop by the head office (or warehouse or factory) of the company you are interested to invest in. Do this unannounced (very important), during business hours (also very important). Here are only some of the major things you will learn:
- gain a sense of employee morale
- how clean, efficient, and accessible is their location
- are they crazy-busy, or mainly just sitting around and twiddling their thumbs
- are the key management present and available to the employees
While you are there, ask some employees questions, see if you can try out the products, even take pictures (which they almost certainly will try to prevent you from doing). Just don't get in their way, bother them, or overstay your welcome.
Typically, you will walk away with dozens of subtle insights, which you would NEVER have been able to ascertain from their web page, online chat rooms, by reading their financial statements, or even through an over-the-phone conversation. From all of that, will grow absolutely stellar clarity, and thus very profitable trading decisions.
5. Sleeping With the Enemy
Typically, when you speak with a company about their product, they will cast the item in the best light. They may rattle off lists of how great their service or widget is while avoiding any of the negatives.
Just as often, if you ask a representative of the company who they would consider to be their main competition, they may say something like, "we don't have any competition." That, of course, is inaccurate bravado, stated by a biased corporate cheerleader. It will be difficult to glean any clear review of their wares by speaking with those who create and market the items. Everyone thinks their product is the best, vastly superior to anything else being sold on the shelves in the same store aisle.
However, there is something you can do to get around the product's producers; Ask their direct competition about the item. By doing this, you will learn about how the companies, which manufacture the competing wares, see the other company's offerings. They will gladly go into detail about the weaknesses and shortcomings of the other and will take plenty of time to express all the ways that it is inferior (and why).
Keep in mind, you want to seem interested in the products of the new company, in order to generate a longer and more involved review or comparison with the other (original) business's wares. When you get the competition talking about the differences between the various choices, you will enjoy their thorough and critical view of the company you wanted to investigate in the first place. You may be surprised by all the insights and thoughts you learn, which never could have been uncovered by simply speaking with only the company itself. With a simple and quick phone call to the competition, where you show interest between all the various choices, you will discover several insights which will help further your due diligence.
By using these five little-known strategies, you may be able to give your investing results a major boost. Each of these tactics is effective and have withstood the test of time.