Primarily, there are two types of investing.
Value investing: In this, the investor looks for bargains. They buy the stocks that appear to be cheap. The problem with this fundamental based value investing is that the stock looks a good buy even when its prices are falling. Value investing is based on buy and hold (hope) for generating wealth over a period.
Momentum investing: Investors buy stocks that are in demand and are moving up. These investors buy at high prices and hope to sell at even higher prices.
Market timing investors: Markets have cycles. These depend on general economic conditions and interest rare scenarios. These investors bet on the market when conditions are favorable and withdraw when they are not favorable. Market timing is generally based on trend following methods.
Trend following Systems: These systems use market price trends to make buy and sell decisions. Here, we do not predict the future prices and simply follow the market. When the market is moving up, we buy. When the system gives an indication that market is moving down, we exit the market.
Why use mutual funds?
Mutual funds give us diversification in a single transaction. We buy into potentially good companies from various sectors (identified by the fund manager) in a single purchase. There is no time wasted in identifying and analyzing various companies.
Trend following based investing system: The system uses a simple parameter to identify conditions that are favorable to investment. These may use price as a simple parameter as it is objective.
Advantages of trend following based system:
- The system is based on objective rules and, hence, decisions based on systems are not emotional.
- The rules can be tested on historical data to confirm profitability before any investment is made using the system.
- There is very little time needed to make the decision.
- There is no anxiety during periods of market fall as we know that we will exit the market when the system gives us the signal.
- There is no need to track news on economy, market, companies, politics etc.