The market has been on a tear this year. In fact, the market has been on a tear for the last 8.5 years, with all of the major indexes at all-time highs, along with countless numbers of stocks doing the same.
Fortunately, there are plenty of investors capitalizing on these gains, while many others are handily beating the market and doing even better.
But far too many investors are underperforming the market. And this should not be.
So what's the best trading strategy to take advantage of today's historic bull market?
There are lots of different trading styles out there: Growth, Value, Momentum, Income, and more.
Some of these are more conservative while others are more aggressive.
But which one works best?
Let's take a look.
Growth traders are primarily focused on stocks with aggressive earnings growth or revenue growth (or at least the potential for aggressive growth), which should propel their stock price higher in the future.
You'll often find smaller-cap stocks in this category because these are typically newer companies in the early part of their growth cycle. But you'll also find plenty of mid-caps and large-caps with stellar growth rates too.
However, there's more to picking growth stocks than simply looking for those with the highest growth rates. In fact, companies with the highest growth rates have been known to perform almost as poorly as those with the lowest growth rates.
How can this be? It's because sky-high growth rates are unsustainable. And they can be priced for perfection.
For example, a company earning 1 cent a share that is now expected to earn 6 cents, has a 500% growth rate. But if it receives a downward estimate revision to 5 cents, that's a significant drop. Even though it still has a 400% growth rate, the estimates were just reduced by -16.7% and the price is likely to follow.
If you've ever wondered how a stock with a triple-digit growth rate could possibly go down, that's how.
By concentrating on Zacks Rank #1 and #2 stocks, growth traders can easily find companies exhibiting strong growth rates that are also displaying upward earnings estimate revisions, setting the stage for growth to continue.
Value investors and traders favor good stocks at great prices. This does not mean they have to be cheap in price though. The key is the belief that they're undervalued. That they are, for some reason, trading under what their true value or potential really is. The value investor hopes to get in before the market 'discovers' this and moves higher.
This deviation from their fair value is what creates exceptional upside opportunity.
Those interested in value will typically look at valuations like P/E ratios, PEG ratios, Price to Book ratios, and more.
Of course, some stocks are cheap for a reason. Or they may appear undervalued on one metric, but not on another.
Too many so-called value stocks have low valuations because they don't have compelling enough earnings or growth rates to speak of. Why pay up for a company if there's nothing to pay up for?
So it's not enough to just look for the stocks with the lowest valuations. They might be low for a reason. Or worse, they might be damaged in some other way, causing other investors to ignore them. These types of stocks are not value stocks. And they are definitely no bargain.
The key for value stocks is a combination of both earnings and valuations. When a stock has a Zacks Rank #1 or #2 that means earnings estimates for a stock are rising.
Given this new information, other investors will view these stocks as being undervalued relative to its future prospects and thus create buying demand for these stocks.
More . . .
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Momentum traders look to take advantage of upward trends in a stock's price or earnings. They believe that these stocks will continue to head in the same direction because of the momentum that is already behind them.
We've all heard the old adage, "the trend is your friend". And who doesn't like riding a trend? In fact, studies have shown that stocks making new highs have a tendency of making even higher highs.
Rather than simply looking for price trends, the Zacks Rank is about cause and effect.
The cause of the move is positive earnings estimate revisions. This upward shift in earnings estimates prompts more and more investors to take an interest in the company with the effect being that shares start on a bull run. Volume increases, as does the stock price.
But just relying on price movement alone doesn't alert investors until after the move has already begun, costing active traders opportunities to maximize profits.
Conversely, by focusing on earnings estimate revisions, the Zacks Rank can identify stocks that are likely to move up in the future, before the breakout has occurred!
The Zacks Rank helps traders get in ahead of the price action. And the momentum effect is quite strong among Zacks Rank #1 and #2 stocks because as earnings estimate revisions rise, prices race to keep up as future estimate revisions are anticipated.
Investors looking for income producing (dividends) stocks are well served by looking for both growth and income, i.e., companies with stable earnings growth that pay a solid dividend.
Oftentimes, these companies are more mature, larger-cap companies that no longer have the kinds of spectacular growth rates like some of the younger or smaller companies, or like they themselves had when they were younger and earlier in their growth cycle.
Many of these companies are generating huge amounts of cash, but because of their size, may not have the growth opportunities they once had.
For example, an idea that generates $1 billion in profits for a $1 billion company represents a 100% growth rate. But that same $1 billion idea applied to a $10 billion company only represents a 10% growth rate.
In other words, it's much harder to move the needle on earnings, the bigger the company gets. So, many of these companies will pay out a portion of their earnings to shareholders in the form of dividends.
The Income investor will want to look at a number of fundamental factors like the company's balance sheet, its competitive advantage, and its management. But the most tangible proof that a company is worth holding for the long-term is earnings. Look for companies with steady and consistent growth over time as they will be in a better position to raise their dividend over time as well.
There may be fewer dividend paying stocks in the Zacks Rank #1 group, but there will be plenty of #2's, and you might even consider some #3's for the larger-cap companies.
Special Situation Strategies
In addition to the four main fundamental styles of trading and investing, there are other special situation strategies that key in on very specific signals and events.
Some are lesser known styles like the practice of analyzing the buying and selling of corporate insiders, or following the money flow of institutional investors.
Others are even lesser understood, like the methodology of trading in front of an earnings report (expecting a positive surprise), or focusing only on international stocks.
Some, however, are very popular and have broad appeal -- like using ETFs for sector and industry bets, trading with options either with or instead of stocks, and the application of technical analysis for timing the market and capturing its twists and turns.
And the #1 Trading Strategy Is...
...the strategy that's right for you!
No one style or strategy is better than the other. They're just different from each other.
And that's fine.
The number one trading strategy is the one that that picks the kinds of stocks you want to get into.
Because if you find yourself getting into stocks that are not in alignment with who you are or want to be as a trader, you'll find yourself dropping that strategy the moment the market hits a rough patch. Or talking yourself out of winning trades altogether, because you're uncomfortable being in stocks that don't fit your style.
You Can Beat the Market
Beating the market isn't just for the pros. Anybody can do it with the right strategy.
So step one is identifying which strategy is right for you.
And for the next 7 days, I invite you to see how all of our different Zacks strategies perform and view our private trades through our unique Zacks Ultimate arrangement.
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Thanks and good trading,
Kevin Matras serves as Executive Vice President of Zacks.com and all of its leading products for individual investors. He is also the Editor of his personal portfolio service, Options Trader.