It seems obvious - but one of the keys to successful investing
is to do what works.
Do what works. And don't do what doesn't.
The problem many investors have is
how
do you know what works and what doesn't?
This reminds me of an actual conversation I had with someone
several years ago who was 'stuck' in a losing stock.
I asked him why he was still in it if it kept on losing
money?
He said he didn't think it would go much lower.
I asked him if he thought it would have gone this low when he
first bought it?
He of course said no.
I then asked him if he thought it would go up from here?
He said eventually, but probably not right away. He then added
that it may still go down some more first.
I told him there are plenty of stocks going straight up. Why
don't you get out of the one that's losing you money and get into
a better one?
He said he didn't know of any better stocks to get into.
I then asked him: "what if you did know of a better stock to
get into, would you do it?"
His answer of course was Yeah! But then he quickly added that
he didn't know how to find 'better' stocks.
And that last comment said it all.
He was in losing stocks because he didn't know how to pick
better
ones.
But if he had a proven, profitable, stock picking strategy, he
could.
So How Do You Know if a Strategy Works or Not?
The answer is backtesting.
But first you need a reliable way to pick stocks.
Don't be the guy who buys a stock because it was talked about on TV
or because he got a tip from a friend.
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Start with a stock screener.
Even if you don't use a screener now, most people still do their
own 'screening' one way or another. They may hear that a stock has
a certain Growth Rate, or a certain P/E Ratio, or Sales Surprise,
or whatever.
They then find themselves listening for, or reading about, or
surfing the Internet -- for stocks that meet this criteria.
Well, if you want to find stocks that meet certain criteria, you
can find them quickly and easily with a stock screener.
But, just because you narrow down 10,000 stocks to only a handful
doesn't necessarily mean that you've picked the best stocks on the
planet.
You might have picked the worst ones.
But with backtesting, you can test your screen (i.e., stock picking
ideas) to see how good (or bad) your screening strategy would have
performed in the past.
- In other words, does your screening strategy generally find
stocks that go up once they've been identified?
- Or does your screen generally find stocks that get buried
once they've been identified?
This is good stuff to know.
With backtesting, you can see how successful your stock
picking strategy has performed in the past, so you'll have a better
idea as to what your probability of success will be now and in the
future.
Of course, past performance is no guarantee of future results, but
what else do you have to go by?
Think about it: if you saw that a stock picking strategy did
nothing but lose money, year after year, period after period, stock
after stock, over and over again, there's no way you'd want to
trade that strategy or use that screen to pick stocks with.
Why?
Because it has 'proven' that it picks bad stocks.
Sure, it may turn around and start picking winners all of a sudden
-- but it may also continue to pick losing stocks the way it always
has.
On the other hand ... what if you saw a strategy that did great
year after year, period after period, over and over again -- you'd
of course want to trade that strategy.
Why?
Because it has proven to be a profitable trading strategy.
And while it may start picking losers all of a sudden
(now that you're using it - right)
, it may also continue to pick winning stocks, just like it had
been doing over and over before.
Don't get me wrong, just because you have a great strategy for
picking winning stocks, it isn't going to preclude you from ever
having another losing trade. On the contrary, even some of the best
strategies 'only' have win ratios of 65%, 70% or 80%. (Not 100%.)
But if your strategy picks winners far more often than losers, once
you find yourself in a losing trade, you can quickly cut your
losses and feel confident that your next pick will have a high
probability of succeeding.
And that's why someone should use a good screener and a backtester
for picking stocks.
To get started, I'm inviting you to download our
Research Wizard
stock-screening and backtesting program for 2 weeks free. Enter
your favorite criteria and out pops a list of stocks. Backtest it
to see how it would have performed in various market conditions.
You're also welcome to take a free look at the stocks that come
through some of our top-performing strategies, like the Filtered
Zacks Rank, the R-Squared EPS Growth strategy or Big Money Zacks,
which has been dubbed the Research Wizard's "Super Strategy". Since
2001, it has averaged a yearly gain of +67.4%.
Get details on your
Research Wizard
free trial >>
Thanks and good trading,
Kevin
Zacks VP Kevin Matras is our stock screening expert. He runs
the
Research Wizard
and personally developed many of its built-in market-beating
strategies.
To read this article on Zacks.com click here.
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