I’ve always been motivated by the idea of finding an ideal mechanical strategy in investing – a magic formula. One that doesn’t require much thought to implement once the groundwork of setting it up has been done.
I’ve got pretty busy recently and am looking for ways to manage my time more effectively. One of the things I’ve been considering is whether there are any ways to simplify my approach to investing to something more mechanical.
Why more mechanical?
First, part of the benefit of a more mechanical approach is that this makes things simpler and easier. This is appealing to me at the moment as I’m finding monitoring my watchlist using the spreadsheet I’ve set up too time consuming.
Second, a more mechanical approach removes the possibility of behavioural investing mistakes. There is evidence that human intervention can detract from mechanical stock-picking strategy. I remember reading that Joel Greenblatt’s investment firm would send a list of investment candidates that had been identified using its ‘magic formula’ to its clients. Clients then decided whether to pick the shares themselves or have them selected at random. Those that picked the shares themselves did significantly worse.
I’m not confident that I’m immune to this. I have outperformed my buy and hold benchmark portfolio, which holds all the shares in my watchlist, since I started it. However, this has slipped a bit lately so it has got me wondering whether a simpler mechanical strategy might be better.
What mechanical strategy is better?
I’m happy to keep my approach to identifying quality shares for my watchlist. This is still the core part of my strategy and I don’t think can be done well mechanically. However, what to buy from it and when to sell could be more mechanistic.
I’ve considered a few options and the main one I’m drawn to is a simple mechanical momentum-based strategy. For example, I could hold the highest momentum shares from my watchlist and rotate them periodically, replacing the lowest momentum share from my portfolio with the highest momentum from my watchlist. This would make it simpler to decide what to buy and could restrict the level of trading.
As well as being a lot simpler to implement, I’m not sure this approach would do worse than my current one. It is more clearly consistent with the overall rationale for my strategy and doesn’t require me to carry out a somewhat arbitrary ‘balancing’ of quality, momentum and valuation. Periodic rotation rather than active monitoring could also provide some clearer discipline my trading.
Ready to hand over the controls?
Not quite yet.
One thing I do need to change is regularly updating the scoring in the watchlist spreadsheet, principally because this is taking up too much time and causing me to monitor the market too frequently. I’ve also lost a bit of confidence in the scoring system – it has started to feel a bit arbitrary. Replacing this with a single momentum indicator (like the six month price momentum or the Stockopedia momentum rank) seems like a sensible alternative. I like the clarity and simplicity of sorting my watchlist this way.
That said, I’m not sure about applying a totally mechanical approach yet. For now I’m going to let the momentum indicator be a guide as to what to buy rather than follow it religiously, and I’m not going to restrict the timing of my trades. But I will set up mechanical benchmark portfolios based on momentum and weekly rotation of one share. These will replace the current ones based on the old scoring in the watchlist spreadsheet.