Successful Stock Market Trading Strategies

By: Ryan Cockerham | Reviewed by: Ashley Donohoe, MBA | Updated May 10, 2019

For many newly established investors, the prospect of actively trading in the markets can be intimidating. After all, it is almost impossible not to be overwhelmed by the sheer variety of investment platforms, assets and lingo that are now an inherent element of modern investing.

Although mastering the markets may take years of patient study and practice, there are a variety of relatively straightforward stock trading strategies that you can begin using right away. These include growth investing, value investing, mutual fund investment and IRA investments, among others. In each scenario, you should be able to make knowledgeable, well-researched trading decisions using market trading strategies that guarantee the best possible chances for a lucrative return.

Tip

Finding the perfect market trading strategies will largely depend on your current experience level and investing goals. Growth investing, value investing, mutual funds and IRAs are all powerful elements of modern trading strategies.

Growth Investing and Stock Trading

Generally speaking, growth investing is defined as the identification of companies which, through careful research, are considered to be capable of growing faster than the average index rate. The primary objective of growth investing is the greatest possible increase in the investor's capital gains.

In many scenarios, the companies identified in this strategy are evaluated based on a set of five parameters, those being:

  1. They have demonstrated a history of above-average earnings.
  2. Whether or not the company's forward earnings growth, or its anticipated earnings for next quarter, matches investor expectations.
  3. The effectiveness of management at controlling costs while simultaneously boosting revenue.
  4. The current style of oversight deployed by management.
  5. The likelihood that the asset will double in value within five years.

Evaluating a company based on these five parameters will allow you to gain a clear idea as to whether it would likely qualify as a viable element of a growth investment strategy.

Growth Investing and Emerging Companies

Another facet of modern growth investing is selective investment in smaller, emerging companies whose current share price may not reflect the true potential of the company. For example, if an investor believes that a relatively small publicly traded company has the potential to grow tremendously based on their products and services, they would likely qualify as a viable candidate for growth investing.

Keep in mind, however, that this particular element of the trading strategy can be somewhat risky due to a variety of reasons. Particularly in situations where a company has yet to deliver the product or service in question, it is entirely possible that the company could fail and the stock would be completely devalued, resulting in a total loss of investment funds.

It is also important to note that smaller companies will typically have a substantially lower trading volume than big-cap stocks. Because of this, it is quite likely that the stock will be subjected to increased volatility and may be harder to sell if prices start to decline rapidly.

Understanding Value Investing

Fundamentally, value investors seek to purchase stocks whose current sale price is below what the investors consider to be its inherent value. In many ways, value investing is no different than shopping sales. After reviewing available stocks, investors seek out selections which, for whatever reason, are currently undervalued.

A stock may become undervalued for a variety of reasons. For example, a general market downturn due to a loss of investor confidence could push the sale price of a stock below its intrinsic value. Other issues, such as disappointing quarterly earnings reports or media scandals, could also temporarily push the price of a stock below its current worth. It is in moments like these where value investors purchase the stock in question and hold the asset until its sale price returns to or exceeds its intrinsic value.

Important Data Points for Value Investing

Investors primarily rely on a stock's price-to-earnings ratio, also referred to as the P/E ratio, and its earnings yield. As expressed in the term itself, the P/E ratio is a quantitative measurement of the price a stock is currently selling for relative to the specific earnings per share reported annually by the company.

So, for example, if a stock has a P/E/ ratio of 10, this means that the current price of the stock is 10 times greater than the earnings per single share of stock the company has produced. As a general rule, value investors seek the lowest possible P/E ratio when selecting viable stock targets. This is due to the fact that stocks with high P/E ratios may already be overvalued which would then likely lead to a price correction rather than growth. A stock is commonly considered a desirable investment opportunity for value investors if its P/E ratio is below 10.

Understanding Earnings Yield

Directly related to the P/E ratio of a stock is its earnings yield. Earnings yield is defined as the value of the earnings per share of a company for the most recent 12-month period expressed as a fractional amount of the current market price of the stock. Essentially, the earnings yield of a stock is the exact inverse of its earnings multiplier.

As an example, consider the following: A company has a 12-month earnings per share value of $3.75 per share. The current value of the stock is $17. In order to calculate the earnings yield, use the following equation:

(earnings per share) 3.75 / (current market price) 17 = 0.22.

For value investors, the higher the earnings yield, the more attractive the stock becomes as a potential investment.

Beginning Mutual Fund Investing

For those investors who are hesitant about trading single stocks, a mutual fund may be one of the better market trading strategies available. By definition, a mutual fund is a collective pool of money that is actively overseen by a fund manager and is invested in various stocks, bonds and other assets as part of a revenue generation strategy. An important early distinction to be made is that a mutual fund does not necessarily have to be composed exclusively of stocks. In fact, many of the most successful mutual funds in existence today carry a highly diversified portfolio in order to hedge against various forms of market turbulence.

There are two basic forms of mutual funds open to investors today: closed-ended funds and open-ended funds. These two labels help define how investors purchase shares in the fund and how exactly these shares gain or lose value over time. Understanding this distinction will help ensure that you know exactly how your money is being invested.

Open-Ended vs. Closed-Ended Mutual Funds

If you are planning on purchasing a stake in a mutual fund, you may be surprised to learn that some of these shares are not available in the stock market. This is due to the fact that open-ended funds have a virtually limitless number of shares available and are traded outside of the stock market. A fund manager running an open-ended fund can agree to take on as much capital from investors as they feel confident they can reasonably manage.

They accrue this capital through the issuance of shares, which are directly purchased from the fund itself. With this idea in mind, the prices of shares of an open-ended fund are not exposed to market activity in the same way that standard stocks are.

An open-ended fund's share price is fixed for a trading day, meaning that shares can be purchased throughout the day at the established price. Changes in share price will be a direct reflection of the net asset value, or NAV, of the fund itself. Once the price of the open-ended share is established, individual shares cannot be purchased for any other price during the trading session.

Pricing Closed-Ended Mutual Funds

The pricing methods used for closed-ended funds differ greatly from that of open-ended funds, due primarily to the fact that there are only a fixed number of closed-ended shares available. These shares exist in limited supply and are traded on stock exchanges just like any other stock. Shares are first offered to investors as part of an initial public offering, or IPO, just as they would be with any other stock. Once the shares have been created and offered via the IPO, no additional shares can be created.

Given the fact that these shares trade in the open marketplace, the price of a closed-ended fund share is influenced by investor sentiment just as much as it is by the actual value of the assets in the fund itself. Given the fact that closed-ended fund shares are traded in the public markets, the price of these shares can fluctuate significantly throughout a single trading day. Fluctuating levels of supply and demand typically result in shares of closed-ended funds trading above or below the net asset value of the fund itself.

Basics of Investing in IRAs

Most market experts advise that newly established investors clearly define their investment goals before they begin trading in the markets. The reasons for this are relatively simple: if an investor knows what their desired result is before they begin trading, certain investment platforms may be far more conducive to reaching them.

As a great example, consider the topic of retirement. Many working adults invest in the market in order to help create a "nest egg" that they can use to sustain themselves during retirement. One of the most popular market platforms that is directly tailored to these goals is an individual retirement account, or IRA. IRAs are unique in the fact that they offer specific tax advantages to investors in exchange for keeping their funds invested for an extended period of time.

Roth IRAs vs Traditional IRAs

Any discussion of IRAs will undoubtedly compare traditional IRAs and Roth IRA plans. In both scenarios, investors can deposit funds up to a federally mandated limit annually. Upon reaching the age of 59 1/2, account owners can begin withdrawing funds from their IRA. It is during this distribution process that the clear differences between Roth IRAs and traditional IRAs emerge.

With a traditional IRA, individuals can exempt the income they place in the IRA from their annual tax reporting. Essentially, these funds can be deposited directly into the IRA and are not reported as income on that year's tax return. However, during the distribution period, withdrawals from the account will be taxed at normal income tax rates.

This process is quite different from the Roth IRA, due in large part to the fact that individuals are required to pay tax on their Roth IRA contributions at the time the investment is made. In exchange, they are not required to pay tax during the withdrawal process. Given the fact that the funds in their account may grow tremendously over the duration of the account, an initial tax payment may be significantly less than the tax on a withdrawal at a later point.

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About the Author

Ryan Cockerham is a nationally recognized author specializing in all things business and finance. His work has served the business, nonprofit and political community. Ryan's work has been featured on PocketSense, Zacks Investment Research, SFGate Home Guides, Bloomberg, HuffPost and more.

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