Is There Truly A Magic Strategy For Trading?
One question almost every single investor asks is whether it is possible to achieve market returns by choosing a diversified group of stocks in accordance with a formula, as an alternative to having to assess every stock from every angle.
Several investment writers have proposed at least one such formulaic strategy during their lifetime. The most promising formulaic approaches have been articulated by 3 men: Benjamin Graham, David Dreman, as well as Joel Greenblatt.
As each of those approaches appeals to logic and common sense, they're not unique to these three men. But, these are the three names with which these strategies are usually most closely associated; so, there's very little need to draw upon sources beyond theirs.
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Benjamin Graham wrote three books: "Security Analysis", "The Intelligent Investor", and "The Interpretation of Financial Statements".
Within each book, he hints at numerous workable approaches both in stocks and bonds; on the other hand, he is most specific in his best known work, "The Intelligent Investor".
David Dreman is identified as a contrarian investor. In his case, it can be an appropriate label, on account of his keen interest in behavioral finance. However, in most cases the line separating the value investor from the contrarian investor is fuzzy at best.
Dreman's contrarian investing techniques are derived from three measures: price to earnings, price to cash flow, and then price to book value. Of those measures, the price to earnings ratio is certainly the most conspicuous.
Lastly, there is Joel Greenblatt's "magic formula". This is the most interesting formulaic approach for investing, both since it does not subject stocks to any true/false tests and simply because it's a composite of the two most significant readily quantifiable measures an investment has: earnings yield and return on capital.
As you'll recall, earnings yield is simply the inverse of the P/E ratio; so, a stock with a high earnings yield is basically a low P/E stock. Return on capital may be thought of as the quantity of pennies earned for each and every dollar invested within the company.
The exact formula that Greenblatt uses is described in "The Little Book That Beats the Market". Greenblatt claims that his magic formula may be used in a couple of different ways: as an automated portfolio generation tool or as a screen.
For an investor like you (that's, one with enough curiosity and commitment to frequent an internet site like this) the latter use may be the more appropriate one. The magic formula will serve you well as a screen.
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