An investment plan which suits your risk appetite is a good way to start investing in stock markets. It helps in achieving your financial goal in an easy and clear way. It gives you a specific purpose to be in markets. But is a strategy enough for your investments to be viable? or Does one need much more than a strategy? Most of us have long-term and short-term goals. Can a strategy which works for the long-term work in the short-term? Naturally, the answer is No. So, how does create a strategy which works to a considerable extent in markets? In essence, it is important to be aware of elements which make an investment strategy work in markets.
Here are a few characteristics of a good strategy:
- Rule-based
A good strategy must have clearly defined framework of rules. It should not be ambiguous. For example, a very basic investment strategy such as buying a stock if its five-day moving average crosses 20-day moving average from below. Also selling a stock if its five-day moving average crosses 20-day moving average from above can be a rule you can set for your investments. This leaves no scope for imagination or change.
- Back-tested
A good strategy should be based on empirical data. Investors should have observed variables on which a strategy is based in the past. For example, a strategy, which calls for buying companies with more than 15% return on equity for the past 10 years, is a long-term investment. If you are keen on any such strategy, then check how such companies have rewarded investors from eleventh year onwards. Technical indicators based price-volume strategies can be back-tested for success rate, drawdown and consistency among other factors.
- Objectivity
A good strategy must have clear objectivity. There should be as little as possible scope for subjective judgment. This can be understood with an example. A company is in cigarette business. It is doing well and rewards its shareholders with consistent dividends. Just because you are a non-smoker and you hate smoking, it should not prevent you from investing in cigarette business. This is a personal bias. Hence, objectivity about investments is a must for a successful investment strategy.
- East to execute
The investment strategy should be easy to execute. If there are too many slippages then the strategy may look good on paper, but may not work in reality. While back-testing does show a certain level of success, one should also check if the underlying stock or index you are trading into has adequate liquidity. This is especially true in the case of small-caps and derivatives on stocks.
- Review-realign and- re-deploy
When you implement a good investment strategy you make good money. However, it does not work, always. This does not mean that the strategy is wrong or ineffective. Sometimes, changes in the business environment or changes in regulatory framework also impact the outcome of a good investment strategy. You have to keep reviewing your strategy. Hence, always record your transactions and keep track of its outcomes. When you review your strategy at regular intervals, you get opportunities to realign it. You can re-deploy funds through such realigned strategies and gain from it amply.