One phenomenon I find holds true in trading and investing is that some things that diehards think should not go together just work.
It’s a lesson I learned early. It came from my love of eating, which led to my love of cooking. Specifically, it was a batch of hot, gooey brownies followed by a swig of beer – and, believe it or not, how delicious that odd combination turned out to be – that taught me to explore what the unexpected could do…
In this case, the unexpected combination that makes this strategy work so well pairs value investing with technical trading. This open-minded approach made my investing immensely more profitable because it turned me on to a “trick” that got me 70% fewer losing trades…
And I’m sure anyone who tries this trick – even dyed-in-the-wool value investors – is going to be delighted with their returns, too…
Improving on the Work of Graham and Buffett
Two of the most important names for value investors are Benjamin Graham and Warren Buffett.
Benjamin Graham is considered the “father of value investing.” When he passed away in 1976, after a long and wildly successful investing career, his protégé Warren Buffett continued in his footsteps, digging deep into the data to find undervalued stocks – as all value investors do.
Graham and Buffett both laid out many ways for value investors to find those companies that are great values.
For instance, they can use the “margin of safety,” or the amount a company trades below its intrinsic value.
And then there’s “Graham’s Number,” which is the concept of subtracting a company’s total liabilities from their current assets and then dividing that number by the the shares outstanding. Graham himself looked for stocks where the price was 66% of the Graham’s Number – a deep value.
Later on, Buffett put his own spin on Graham’s teaching. He looked only at the raw balance sheet and income statement numbers, and had a good feel for less easily measured characteristics like competitive advantage and management strength.
Following in these giants’ footsteps, today’s value investors in general look for either distressed companies at fire-sale prices or strong companies that are trading at a significant discount. And many a great stock or opportunity is found.
The problem is that value investors are notoriously early.
Wall Street is practically paved with sayings about buying stocks too soon during a down move. “Don’t catch a falling knife” or “don’t catch a falling piano” are similar phrases that remind us that buying too early can be painful.
So what is the well-informed value investor to do?
Well, they can do what technical traders – like me – do when they’re looking for good prices on great stocks at the right time.
The One Easy Trick to Find a Better Entry Point
When I was writing The New York Times best-seller “Safe Strategies for Financial Freedom” with my partners – one of whom is a legendary value investor in his own right – we looked at a series of my partner’s value picks to see if adding an entry strategy to his excellent analysis could improve results.
We looked at a series of 21 longer-term investments that he had recommended.
As expected, they did quite well, earning an average of two-and-a-half times the initial risk amount. But we found a way to get even more.
To improve on those numbers, we added a simple entry filter that limited buys to stocks that are heading in our direction. We defined this as a stock that was higher on the purchase day than it was eight weeks, or 40 trading days, ago.
The results were stunning – using this entry discipline, 70% of the losing trades were eliminated! And just one of the stocks that passed this simple technical filter ended up as a loss.
Using two entirely different and even opposed approaches to investing improved our results impressively.
Value investing can be a great way to real bargains in the market. But if you add a simple technical entry filter that keeps you from “catching a falling knife,” you can avoid some of the instances where you buy a bargain… that keeps on falling.
At the time of our experiment, we found that eight weeks was the optimal timeframe for this filter, but times have changed. In today’s faster markets, my research has found that five to six weeks (25 to 30 days) is a great filter for longer-term investment entries.
So here’s the rule: Once you’ve identified your value stock, only buy it if today’s price is higher than the price six weeks ago.
This will make sure that you’re not buying a stock while it’s still under downward momentum. And while this requires a bit of patience, it’s a practice that I’ve found pays off in the long run. Your patience will be rewarded when you do this across many trades.
And as for beer and brownies – try it! Let me know what you think.
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