Holding on to fundamental analysis and stock picking software only keeps you stuck in stock trading. Trading in this manner compounds the risk of concentration in one asset class and fails to adequately diversify risks between stocks, bonds, currencies and commodities. There is much more to trading stock options than the stock itself.

I cite Benjamin F. King’s study, cited repeatedly since 1966, because it is still valid and has not yet been refuted to the point of dismissing its logic.

Market and Industry Factors, Journal of Business, January 1966: “On the movement of a stock…

• 31% can be attributed to the general stock market,
• 13% to industry influence,
• 36% influenced by other groups, and the rest
• 20% is owned by a single action.

There must be a more compelling reason for you to trade shares other than just the move, if only 20% is exclusive of the underlying equity in question. Consider this, in the context of the fundamental analysis or stock picking software you bought for $1. For every dollar you spend, you “outsource” the analysis at a cost of 80 cents, only to receive 20 cents of work. Shouldn’t the 80:20 “outsourcing” rule be reversed? The problem is that you are still stuck with 80% of the work, to analyze the price movement! Also, the more you use FA techniques/stock picking software, the more trading capital will get stuck in just stocks.

Now, you can say that “special” research papers help you choose stocks. Let’s take a look at some of the most common fundamental metrics across these research subscriptions:

1. Dividend Yield: The problem lies in the variability of returns as companies are at different stages of their business development. A mature company that dominates in a well-established sub-segment/sector will be able to afford a different dividend yield; versus, a young company in a growth-oriented field; versus a small company in a growing area that may not be able to afford a dividend payment. Keep in mind that there is nothing special about companies that pay dividends.

A company that gives away a portion of its retained earnings, which is what a dividend is, actually gives away part of its valuation, which means it’s not worth as much as a company that needs to give investors candy to commit capital. . Therefore, a stock that pays dividends has to be much higher than a stock that does not pay dividends for reasons other than the dividend. If not, there is no point looking for dividend paying products to trade, there are many non-dividend paying indices to trade.

2. Price to Book Ratio: The problem is that this metric varies across industries and from company to company, as the asset base and capital structures of companies change over time. Lacks cross-sector applicability and accounting complexity arises from a company’s capital structure as it changes due to acquisitions/divestitures/CAPEX for new product lines; or product line cuts, as seen recently in the restructuring of major US auto companies.

3. Price/Cash Flow Ratio (P/E’s Cousin): Accounting laws on depreciation vary in Asia, Europe, and the US as accounting rules are driven by tax codes, which vary considerably from region to region. Despite the adoption of global accounting standards, there is a lack of uniformity in the homogenization of a fundamental relationship that will fit as a common reference point in all geographies.

These metrics don’t help you compare, say, a US-sourced Dell with a Taiwan-sourced Acer; but is listed as ADR in the US, even though both are competitors in the same industry as PC manufacturers.

In addition, the current shifted cost of capital in credit markets impairs the ability of corporations to cost-optimize their balance sheets. In essence, corporations pocket the working capital cash flows left on their balance sheets, as a testament to their financial strength. Don’t waste your money on fundamental analysis software or research paper subscriptions.

Since there is a fundamental flaw in fundamental analysis and stock selection, how do you select trades? Trade options on a broad-based stock index to replace exposure to individual stocks. To replace fundamental analysis, use the measure of relative strength based on point and figure methods.

What is relative strength? It’s nothing more than taking one price as the numerator, dividing it by another price as the denominator, and then multiplying by 100. RS = (Price 1 / Price 2) x 100. RS calculations typically use daily closing prices. Although simple in its mathematical construction, RS is ingeniously powerful when applied not just within a sector; but, across sectors and across asset classes.

Let’s start within a sector. For example, if you choose 2 semiconductor stocks that are trading at different prices, how do you know if one stock is outperforming the other in the same sector, when the 2 stocks have price changes at different rates? Furthermore, is the sector’s own price also changing?

SOX = Semiconductor Sector Index, trading higher from 452.24 to 467.81.

Numerator1: Price1 = BRCM 33.15 RS1 = 7.33 Price2 = 33.80 RS2 = 7.23

Numerator2: Price1 = TSM 9.91 RS1 = 2.19 Price2 = 13.43 RS2 = 2.87

Common denominator: SOX Price 1 = 452.24 Price 2 = 467.81

RS1 of BRCM = (33.15/452.24) x 100 = 7.33. RS2 of BRCM = (33.80/467.81) x 100 = 7.23.

TSM RS1 = (9.91/452.24) x 100 = 2.19. TSM RS2 = (13.43/467.81) x 100 = 2.87.

The BRCM price rises from 33.15 to 33.80 and the TSM price also rises from 9.91 to 13.43. Just because BRCM is a bigger stock, does that mean it benefits from SOX trading? No, the RS reading (RS1 vs. RS2) shows that the BRCM RS reading fell (from 7.33 to 7.23) vs. the TSM RS reading which increased (from 2.19 to 2 .87). RS confirms TSM as top performer on rising price strength against BRCM’s weakening price. RS is built on pure pricing rules. Using an index as the denominator acts as a much more durable benchmark and is structurally more reliable than any “magic” TA indicator; or a combination of income statements, balance sheets, and cash flow statements promoted in stock picking programs.

You can replace BRCM or TSM with indices or ETFs. The use of indices with relative strength allows a common denominator to compare stocks with bonds, commodities and currencies, to cross over to asset classes other than stocks for trading. Not that relative strength is infallible. But compared to the fundamental metrics cited above, Relative Strength fails less. Break the mold with what you’ve learned about trading stock options.

Are there any examples of a consistently profitable trailing portfolio that trades using relative strength across multiple asset classes? Yes. Follow the link below, titled “Consistent Results” to view an online options retail portfolio that excludes the use of individual stocks and fundamental analysis, using broad-based stock indices, commodity ETFs, and stock ETFs. foreign exchange. There is no need to trade FX directly. Simply trade currency ETF options.