10 Principles to Fast-Track Profitable Investing

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In today’s piece, I am going to break down ten market lessons that I wish I learned earlier. Market participants who thoroughly understand these principles will be on the fast track to profitability. Let’s jump straight into it:

1. Markets Discount the Future

Wall Street and financial markets are master manipulators because they often bottom on poor news and vice versa. For example, Bitcoin bottomed within days of the FTX crypto exchange collapse, and hasn’t looked back since.

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Image Source: TradingView

For equity markets, the psychology is the same. The S&P 500 Index ETF (SPY) and the other major indices bottomed the day inflation hit 40-year highs in the U.S in late 2022.

Zacks Investment Research

Image Source: TradingView

2. Fundamentals Mean Little in a Vacuum

To successfully analyze fundamentals, investors must account for the context of said fundamentals. The struggling e-commerce firm Carvana (CVNA) has soared more than 500% over the past year and provides a perfect fundamental lesson for investors. Why has the stock run so much? In late 2022, Carvana was on the brink of collapse. However, the company secured funding to keep the company in business. Later, it turned its earnings from awful to less bad.

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Image Source: Zacks Investment Research

3. Valuations are Not a Timing Device

An important lesson is that valuation metrics like the price-to-sales (P/S) ratio are not a valid timing tool – especially for innovative growth stocks. While the numerator (price) is known, the denominator (sales) is not known (moving forward). Because of this misconception, Zacks Investment Research heavily weights its analysis and ratings based on forward EPS expectations. Amateur investors would probably be surprised to find that Nvidia’s (NVDA) P/S ratio has actually fallen since mid-2023 despite the massive bull move in the stock.

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Image Source: Zacks Investment Research

4. Strive to Trade Like a Casino (Edge)

Like life, nothing on Wall Street or investing is ever obvious or certain, which is why most active retail investors lose money or underperform. Fortunately, perfection or a very high trade success rate is not necessary to achieve investment success. Think of a casino. Casinos don’t make money on every hand. However, casinos enjoy an edge that, when played out over a large series of hands, pays the bills (and then some). Similarly, investors pay “tuition” to the stock market through stop losses and risk management.

Amateur investors suffer from inconsistent returns because they tend to rely on gut feel and make emotional trades. Conversely, savvy investors leverage historical precedent, data sets, fundamentals and charts to gain an edge.  

5. Take Asymmetric Bets

Amateur investors apply more emphasis to stock picking when they should focus more time and energy on sound money management principles. Fortunately, the math is simple to understand. If an investor risks $1 to make $5 on each trade, they can be wrong 80% of the time and still break even. Using these same numbers, an investor who achieves a 40% hit rate with this reward-to-risk ratio will be highly profitable over a large enough series of trades. Don’t overthink investing; let the math work in your favor.

6. Fundamentals are One Piece of the Puzzle

Though fundamentals are integral to a stock’s long-run performance, other factors, such as changes in share supply, play a role in direction. For example, “animal spirits” and hype have largely driven GameStop’s (GME) super performance over the past few years. Meanwhile, though Apple’s (AAPL) earnings have largely stagnated recently, record share buybacks have decreased supply and increased demand, driving the stock higher.

7. U.S. Markets Rise in Time

Despite war, recession, and countless “Black Swan” events, U.S. equities tend to rise in the long run due to America’s innovative nature. The S&P 500 Index has averaged returns ~100% over the past century. While the market suffers corrections in the short term, understanding the long-term picture pays long-term dividends.

Zacks Investment Research

Image Source: Zacks Investment Research

8. Innovation Breeds True Market Leaders

The best-performing growth stocks are driven by growing earnings, which are sparked by innovation and disruption. For example, Blockbuster was once far larger than Netflix (NFLX). However, Blockbuster failed to recognize that technology was changing and the brick-and-mortar approach to movies would no longer be relevant. Conversely, NFLX pounced on the emerging DVD-by-mail trend, and later, the streaming trend, leading to a life-changing move for its investors.

9. Forward EPS Estimates & The Zacks Rank

Investors can screen a large database of stocks by sorting by the Zacks Rank. Zacks Rank #1 (Strong Buy) stocks signify that Wall Street analysts are becoming increasingly bullish on a company’s fundamentals ahead. Our extensive in-house studies show that Zacks Rank #1 stocks tend to outperform dramatically, all else equal.

Zacks Investment Research

Image Source: Zacks Investment Research

10. Market Direction is King

Approximately 75% of a stock’s move can be attributed to the general market’s direction. The most straightforward way to size up the long-term trend is to plot the 200-day moving average over the major indices like the Nasdaq 100 ETF (QQQ).

Zacks Investment Research

Image Source: Zacks Investment Research

When price is above the 200-day moving average, the market is in a bull phase, and vice versa. Never fight the trend.

Bottom Line

Instead of “trial by fire,” investors can circumvent years of frustration by understanding ten essential principles.

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