3 Proven Ingredients for Improving Investment ResultsSubmitted by JMB Financial Managers on January 10th, 2020
It’s really difficult to achieve consistent investment results. Or is it? It turns out you can dramatically improve your investment results by using three proven ingredients in your investment process. In this post, I’m going to show you those ingredients, and why you should be using all three in your process.
Stop Limiting Yourself to Just One Form of Analysis
Most investors use one, and only one form of analysis in picking their investments. Many use fundamental analysis, some use technical analysis, and a handful use quantitative analysis. But they limit themselves to just one.
Imagine an engineer designing an overpass for the highway. To ensure maximum safety for drivers, the engineer has to understand the properties of steel and concrete (fundamental analysis), local elemental factors like earthquakes, tornadoes, and hurricanes (fundamental analysis), calculus, geometry and physics (technical analysis), plus the ability to use computer models to simulate the design under various scenarios (quantitative analysis).
Just as an overpass designed using only one method of analysis has a much higher probability of failure (with severe consequences I might add), an investor that uses just a single method of analysis has a much higher probability of failure (with potentially life altering consequences in a negative manner).
Let’s take a deeper look into the three ingredients.
Ingredient #1: Fundamental Analysis (What to Buy)
There are various techniques that can be used for fundamental analysis, which seeks to separate the best run companies from the rest, and to determine the intrinsic value of each. Fundamental analysis generally falls into two categories: top-down analysis and bottom-up analysis.
Top-down analysis begins with an analysis of the economy, applying that to the entire market, and then zeroing in on sectors, industries, and finally specific companies. Bottom-up analysis starts with a specific company, then broadens out to consider all the potential factors that could impact its stock price.
This is the most frequently used form of analysis, and requires familiarity and consistent review of the following factors (among others) for best results:
- Price-to-Sales Ratio
- Profit Margins
- Gross Domestic Product (GDP)
- Consumer Confidence
- Federal Reserve Policy
- Manufacturing Data
- Retail Sales
- Trade Data
We like to say that fundamental analysis helps us identify what investment to buy.
Ingredient #2: Technical Analysis (When to Buy)
There are many techniques that can be used for technical analysis, but each can be generally summarized as a study of market action, primarily through the use of charts, graphs, and market data for the purpose of forecasting future price trends of a company.
The term “market action” includes the three principal sources of information available to the investor: stock price, trading volume, and open interest. (Open interest is used only in futures and options.) There are four premises on which the technical approach is based:
- Market action discounts everything
- Human nature never changes
- Prices move in trends
- History repeats itself
This is the second most frequently used form of analysis, and requires familiarity and consistent review of the following factors (among others) for best results:
- Moving Averages
- Chart Patterns
- Bullish Reversals
- Bearish Reversals
- Bell Curves
- Buy-side Volume
- Sell-side Volume
We like to say that technical analysis helps us identify when to buy or sell.
Ingredient #3: Quantitative Analysis (When to Sell)
There are multiple disciplines that can be applied to quantitative analysis, all of which involved the application of mathematics and statistics to the markets and the economy. Quantitative analysis generally includes financial mathematics, financial engineering, applied mathematics, physics or engineering, and computer programming.
Quantitative analysis usually consists of searching vast databases for patterns, such as correlations among liquid assets, price-movement patterns, and intermarket causality made possible by the advancements in computer technologies beginning in the 1980’s. With the recent advent of artificial intelligence and machine learning, it is anticipated that quantitative analysis will grow in use and popularity in the years to come.
We like to say that quantitative analysis helps us understand how investments may respond in certain economic or market conditions and to formulate a plan for those conditions.
Recommended reading to learn more about different investment analysis methods.
If you’re look to learn more, here are a couple of recommended books to broaden your knowledge on the three ingredients needed for a successful investment strategy.
- Fundamental Analysis for Dummies by Matt Krantz
- Technical Analysis for Dummies by Barbara Rockefeller
- Quantitative Finance for Dummies by Steve Bell
Do you have the three ingredients needed to improve your investment strategy?
Most investors (and most mutual funds for that matter) find it very difficult to achieve consistent investment results because they rely solely on one form of analysis when choosing investments, just as the engineer who only used one form of analysis was likely to see their overpass fail and collapse.
Combining fundamental, technical, and quantitative analysis covers the full range of possibilities for an investment, helping you choose which investment to pick, when to buy or sell it, and preparing you for how it might behave under certain economic, sector, or industry conditions before they arise.
Does your current investment strategy include fundamental, technical and quantitative analysis of your investments?
If your current investment strategy does not include the 3 ingredients to improve your investment results, contact JMB Financial Managers to book your free consultation and learn more about our portfolio analysis and management services.