What You Might Be Missing In Your DIY Investing
Improve now. Simple to implement. Feel free to use these takeaways from my hobby investing studies.
In this article I want to list some key measures any investor can directly take to most probably improve investment results from today on.
Not financial advice, just my own findings and opinion. Please do your own research.
These conclusions are from studies I conceived and implemented myself. Though I am a mechanical engineering PhD by training, I really do enjoy transferring engineering practices to finance in my leisure time…
If you want to read more or dive into the methodology and check for yourself, the detailed study stories are linked for each item.
Invest a fixed amount of money each month, usually in a broadly diversified index (via an index fund — ETF). When prices are low, you get more shares of the ETF and vice versa. This leads to an average price at which you effectively bought the ETF. If the current market price of the fund is above that average price, your overall position is profitable.
- Cost averaging works well in sideways to upwards markets, usually on a long time scale (3–5+ years).
- It mitigates the timing risk of a one-time investment.
- However, it’s not a remedy for everything. If market price falls permanently, your average market price may still be higher and you encounter a loss. Especially dangerous if you cost-average into single stocks. And in strongly growing markets, an early one-time investment might be superior.
Modify cost averaging: If market prices are “high”, you invest less each month and vice versa. A simple way to measure “high” market prices is the difference between a 200-day moving average and current market price (price > 200-day MA: “high”, buy less, and vice versa). You can map “high” market prices to a change in your monthly investment by calculating something like percentage difference times a negative factor (-4 in the study).
→ Example:
- Usual monthly investment: $500
- 200-day MA = $100, Market price = $110
- percentage difference 110/100–1 = 10%
- invest -4*10 % less = -40 % less →$500 * (1–40%) = $300
- Thus, +25 % means don’t invest at all
Effect on profits (green arrow):
This can help to reduce the average price from cost averaging (“buy even more when low”) and thus increase profits, as the study showed in detail. Drawback: Not ideal if there is fast and strong growth — then it is better to have more coals in the fire early on.
Fees eat into compounding. Recurring relative fees (e.g., a certain percent per year) on the overall invested sum are especially harmful. Thus, be aware to pick investments with small total expense ratio (TER). Apart from that, limit the number of trades, as these provoke many one-time commissions.
Leverage is risky, use wisely if at all:
Leverage means to lend money and invest that alongside with your money. Thus, your overall investment sum gets larger. If everything goes well, your profits also multiply. But of course the same applies to your losses — these also multiply.
→ Example:
With a leverage of 2 (50 % is your money, 50 % is borrowed) you lose all your investment if the base value (e.g., a stock you bet on) loses 50 % (=100 % / 2). This is because your lender (broker, bank, friend…) wants to secure the loan and will force you to liquidate before his/her money is affected. With a leverage of 8, even 12.5 % loss is enough (=100 % / 8) to lose all you put in.
Plus, there often is higher trading cost for the necessary instruments and interest for the borrowed money. These costs reduce gains and increase losses of positions, as they are unavoidable and must be paid in any case (gain or loss). Use proper position sizing and stop loss:
Trader’s paradise: Stop-loss, Position Size and How to use technical analysis:
- Stop-loss means setting an automatic order to sell after a predefined loss in security price, such as -5 % from recent close price. Yet stop-loss is not an exit price guarantee: It is filled at the next available market price. You might therefore lose more or less than you defined/expected.
- Stop-loss is set on the price of 1 unit (a stock, an ETF share, etc.). Then the position size determines your possible overall loss: If you choose a size of 100 stocks with a stop loss of $1 each, your maximum overall loss is around $100 (depending on filling of the market order, see above).
- Technical analysis application requires a systematic approach, which is backtested, robustness-tested, and encompasses many components such as money management, recent volatility, and reasonable trading quality measures. Even then, it is not easy to find a profitable strategy. It is difficult to prove advantages (if there are any) when trading is discretionary. As I can’t make this much shorter, please refer to my study if interested.
There are a few important key stock metrics. These metrics are collected from several (mostly value) investing books and, in combination, worked well for me.
- Profitability: Gross Profit Margin (operational efficiency), Net Profit Margin (efficiency after all costs), Return on Assets=ROA (efficiency of using its own assets, e. g. machines), Return on Equity=ROE (efficiency of using our capital). → All: The higher, the better.
- Liquidity: Current Ratio (stands for short-term company health) and Debt to Equity (ensures not too much leverage; and avoids artificially high ROE). → Current ratio > 1, D/E not too high — compare within industry, for example.
- Valuation: Price to Earnings Ratio=P/E-Ratio (is it expensive?) → Evaluation depends on many factors, but lower is mostly better. However, if it is exceptionally low, this might also be a warning sign.
Obviously, this is simplifying — these key performance indicators are not applicable to any company or in any situation. But good grades on these criteria might signal that you want to investigate this stock further. And via negativa they may help you identify fundamentally bad or expensive stocks you otherwise would have bought.
Which books to read to enhance your investing skills:
I think that investing works through an accumulation of (sometimes even seemingly unrelated) knowledge. Thus, books such as…
- Graham: The Intelligent Investor
- Pecaut/Wrenn: University of Berkshire Hathaway
- Lynch: One Up On Wall Street
- Heath Brothers: Decisive
- Greenblatt: The Little Book That (Still) Beats The Market
- Kostolany: Geld und Börse (~Money and the Stock Market)
… are a great place to start.
Feel free to reach out for discussion. I am happy if you follow me if you get value out of my writing.
Thank you for reading and have a great day.
DISCLAIMER: This article presents a summary of my own learnings based on studies generated on synthesized (random, i.e., artificial) data which is statistically similar to real-world time series, and personal experience. The content is, thus, purely educational. Past performance is not a reliable indicator of future results. The article should not be considered Financial or Legal Advice. Consult a financial professional before making any major financial decisions.
