Simple Stock Trading Strategies
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In this review we look at the book The Lunchtime Trader.
The author, Marcus De Maria gained popularity when he was host and expert on the TV programme Stock Market Secrets. A well-respected financial educator who wrote the book for individuals looking to create financial freedom through the stock market.
The book offers another rag to riches tale in which Marcus started with £150,000 worth of debt and later became a millionaire. He used a few specific trading strategies which he refers to as the Buffalo strategy and the VCA strategy, both of which we review in this video. Let’s take a look.
After a few failed ventures Marcus found himself saddled with debt and sleeping on his brother’s floor. Fast forward several years and he now teaches people the methods he used to become financially free.
Before teaching specific trading strategies, Marcus first emphasises the importance of calculating what he refers to as your Critical Net Worth. He says:-
“Your Critical Net Worth is the only financial goal you will ever need”
The Critical Net Worth is calculated by using two factors; Your expected trading returns and your desired annual income which would cover all your living costs.
Marcus believes that by determining these two factors you can calculate the figure of your Critical Net Worth, and once achieved you can then consider yourself financially independent.
As an example, and to keep the numbers simple, let us assume your minimum living costs equate to 20,000 per year, and you find a strategy which generates 20% returns per year. Your critical net worth figure would therefore need to be 100,000.
100,000 multiplied by 20% equals your 20,000 living costs.
Remember however, the critical net worth is only a target to achieve and not a starting trading account.
We can see here a quick reference point.
On the left we have our expected trading return percentage. On the top, the required critical net worth amounts, and in the middle, the desired annual income.
If the desired annual income is for example 30,000, we can calculate the required critical net worth against each expected trading return.
Marcus’s Buffalo strategy (which we look at shortly) targets more than a 30% return per year, in which case, to achieve our desired income of 30,000 we need a critical net worth (or trading capital) of 100,000.
Next, we look at Marcus’s strategies to help us achieve our desired trading capital.
Marcus starts by saying: -
“We’ve been teaching people for ten years how to make 3% a month (not a year), that’s 36% a year on their savings, by spending as little as 20 minutes a day either in the morning, lunchtime or evening”.
To put this into context, if we started with an account balance of 10,000 and compounded a 3% monthly return, over a 5-year period the account would increase to almost 60,000.
Over a 10-year period this would increase to over 347,000.
Clearly, achieving such returns with a modest starting balance, could see you get to your critical net worth in a relatively short period.
Marcus adds to the importance of compounding returns by asking the question: -
“if you had a penny and you were able to double it each day, how many days do you think it would take to get to over one million pound?”
The first day, one penny doubles into two pennies, the second day two pennies double into four pennies, and so on…
Before I reveal the answer, let me know in the comments below how many days you think it would take to get to over one million pound…
The answer is just 28 days, in fact the end balance would be 134 million pennies (or 1.3 million pound) and shows the immense power of compounding.
Furthermore, Marcus presents another chart which shows a starting balance of just £3000 and monthly deposits of £100 per month. By using the same 3% trading returns per month we can see how the account can grow over time. In just 10 years your account would grow to over £200,000, and by year 15 to over a million.
See the link below for a free spreadsheet showing the growth of your account depending on the metrics you choose.
Let’s now move to the strategies used to achieve such results.
The first trading concept we look at is what Marcus refers to as the Buffalo Strategy.
The Buffalo Strategy aims to produce returns of 35% per year.
We know a bull market represents rising prices, and a bear market represents declining prices. But a buffalo market on the other hand, represents a sideways range of prices.
Marcus looks at the daily chart over a twelve-month period to determine the market direction, although he suggests the theory can be used over any timeframe.
Having established a sideways market, Marcus splits the chart into four zones, zone one being the bottom and zone 4 being the top.
Once this framework is in place Marcus looks for three bounces, from either zone four which is the resistance line, or zone 1 the support line.
In this example we can see three bounces from zone four, at which point Marcus would short the stock in the hope of a continued decline.
Another stipulation Marcus makes is that there must be a risk reward ratio of 3 to 1 available, therefore risking 100 to make 300. Anything less and the trade would not be considered.
Additionally, Marcus says to avoid trading with earnings announcements pending.
From a technical perspective this captures the key points of the Buffalo concept, however Marcus also requires key fundamental criteria to be met.
He says:-
“Technical analysis tells us when to get in or out of a stock, but fundamental analysis tells us which stocks to get into”.
The key metric to look for is the Price Earnings Growth ratio.
The P and E represent the commonly used PE ratio which is price divided by earnings per share.
The G is the earnings per share growth and projects the growth of earnings in percentage terms.
Kindly supplied by Stockopedia, we can see the PEG ratio is predominantly a valuation metric. Also pointing out that a PEG ratio of one is fairly priced, anything less than one and the stock is considered to be undervalued.
Marcus suggests that a qualifying stock must have a PEG ratio of less than 1.5 to be considered.
Next, we look at the strategy which Marcus refers to as VCA, or the Value Cost Averaging technique.
Its concept is similar to the popular Dollar Cost Averaging technique, but with a twist.
Dollar Cost Averaging attempts to achieve an average stock price over numerous purchase points, usually each month, and is often how people (indirectly) invest into their pensions.
Value Cost Averaging on the other hand looks to take advantage of the price fluctuation and adjusts each investment to suit. Therefore, instead of equal investments, Marcus looks to buy more in the lower zone and less in the higher zone. As a result, the average purchase price should be considerably less.
Its important to note however that this technique should only be used on major indexes or gold where there is a bias for price increases over the longer term. Additionally, the technique can be used in either a ranging or upward moving market.
The technique targets a 15% return per year but is less volatile than the Buffalo Technique used on stocks.
In summary, the equation Marcus provides to become financially free, is to first determine your desired level of income, decide on your investment or trading strategy, and allow the power of compounding to reach your critical net worth in the shortest time possible.
Don’t forget to click the free spreadsheet link below and find out just how quickly you can reach your financial goals.
Financial Wisdom