An investment strategy helps bring order and consistency in the naturally unpredictable world of financial markets. But in order for an investment strategy to be effective, it must have certain elements that help the investor identify profitable opportunities and minimize capital risk. For aspiring investors, here are four elements to a good investment strategy.
Investability
For an investment strategy to be effective, you must have enough quantitative data to work with, which means its market or scope must be large enough to identify companies that it can later on use to strengthen said strategy. For instance, if your strategy only works on a specific company size and sector, the data available may be too restricted, leading to low-quality signals. Strategies, such as the O’Shaughnessy Tiny Titans screen, are able to capture and analyze up to 25 companies that meet their criteria.
Cost Efficiency
Whether you’re managing your own investment portfolio or being paid to manage someone else’s, cost-efficiency plays an integral role on your bottomline. There are certain unavoidable transactions that you’ll have to pay money for. And while these individual fees may sound inconsequential, the collective sum of the charges may bite off a huge chunk from your profits or worsen the sting of losses. Your strategy should factor in related fees, such as broker commissions.
Stop Loss and Profit Target
Every investment strategy needs an entry plan and an exit plan. Buying a stock, bond, currency, commodity, or whatever asset you fancy without any plans on how and when to liquidate it can lead to stress and confusion when the position starts to move. Your stop loss should be whatever dollar amount you are willing to risk. The profit target you set should ideally be higher than what your stop loss is for the position.
Risk Control Measures
Any investment venture involves a degree of risk that must be controlled. A good investment strategy that clearly defines risk management measures can withstand the cyclical volatility of financial markets while allowing capital to grow consistently.
Oftentimes, novice investors abandon all logic and reason when they see a position turning against them. In order for an investment strategy to work, you’ll need to be disciplined and consistent with its use and trust that the strategy you’ve chosen will produce returns over time.