Developing the right strategy is a critical aspect of investing, as it allows you to design and manage your portfolio according to your specific investment aims. Learn how to identify the best investment strategy for you, and the positives and negatives of each.
Investment strategies factor in risk-return and investment time-horizons, as well as your personal investment aims. They can help you to spot trading opportunities and manage risk, but the question remains: which investment strategy is the right one for you?
The best way to measure your investing success is not by whether you are beating the market but by whether you have put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.
Benjamin Graham
What is an investment strategy?
An investment strategy is a well-thought-out plan, designed to help you achieve your financial goals. By taking into account your personal circumstances, aims and risk profile, it acts as a high-level guide for your ongoing decisions to buy and sell different assets.
Tip: Strategies are most effective when mapped out prior to investing. That said, as circumstances evolve, so must your strategy.
How to choose an investment strategy
Your strategy must consider what you want to achieve, the timeframe in which you intend to do so and the possible consequences if you fail to meet your target.
The financial markets include a wide range of instruments that can be used to pursue a variety of approaches, from short-term opportunities with high risk-return potential to assets that offer relative stability and consistent income streams.
Popular investment strategies
Everybody possesses a unique profile, but certain strategies can appeal to a wide range of investors. For example, a growing number of investors prioritize following a program designed to secure early retirement.
As a result, investment strategies can be divided into subcategories based on the specific objectives they aim to achieve, each tailored to serve a specific type of investment aim.
Value investing strategy
Value investing involves using fundamental analysis and valuation methods to identify stocks that are trading at prices below their intrinsic value. Stocks can be considered “undervalued” for various reasons, including past reputational damage or other legacy issues.
The value investing strategy operates on the belief that, over time, the market price will correct itself, thus generating a return for those who buy the dip.
Trend investing strategy
Stock markets and economies exhibit natural patterns of expansion and contraction. Trend strategies aim to capitalize on these movements and leverage the price changes in assets that result from such trends.
Because economic and stock market trends can persist over extended periods, investors with long-term objectives are usually more interested in these strategies than those looking for short-term returns. However, even those pursuing short-term strategies could potentially engage in trend trading and try to take advantage of these price movements.
Tip: Investors using trend strategies should monitor market conditions and be prepared to exit positions when necessary.
Momentum investing strategy
Momentum strategies focus on stocks or sectors that are gaining popularity among investors. Indicators, such as an increase in the amount of trading activity or increased share price volatility, can suggest that a stock is about to break out of its historical price range.
A momentum investment strategy is based on the principle that once a stock has started moving in a particular direction, it is likely to continue doing so for a certain period of time.
Quantitative investment strategy
Quantitative investment strategies rely on historical market data and technical analysis tools to spot anomalies in share prices. These strategies operate on the basis that financial markets do not always operate efficiently.
By using statistics and mathematical models, quantitative investors (“quants”) can identify stocks with prices that are momentarily out of line, and for which they expect the stock’s price to change to reflect its long-term fair market value.
ESG investment strategy
Environmental, social, and governance (ESG) investing involves using certain criteria to screen investments based on a company’s ethical policies. ESG guidelines are implemented to encourage companies to act more responsibly.
ESG investing strategies, therefore, provide an avenue for individuals to participate in the stock market while simultaneously supporting progressive business practices and seeking financial returns.
Passive investment strategy
Passive investing strategies are long-term strategies that seek to track the market rather than beat it, perhaps by buying a position in a stock index, for example. This approach is grounded in historical data, which shows that stocks have typically generated inflation-beating returns over the long run. Passive investing is often favored by buy-and-hold investors who have the time to ride out short- and medium-term price fluctuations, but do not necessarily want to pick out individual stocks.
Growth investment strategy
Stock-picking and growth stock investing involves identifying and buying the stocks of companies that are expected to grow at an above-average rate compared to their sector or the broader market.
This outperformance may be triggered by a technological advancement, a change in business structure, or an increased demand for stocks in a particular sector.
Tip: Growth stocks do not necessarily have to be small, but smaller companies have more room to develop market share.
The importance of having an investment strategy
The process of creating a strategy starts with time spent understanding more about your own risk profile. This will then enable you to consider which asset classes offer the appropriate risk-return balance to help you achieve your investment objectives.
The only certainty in the stock markets is that things change, but this should not deter investors from developing a strategy. Your plan can be adapted over time and can even incorporate contingencies, should your personal circumstances change.
Adhering to a clear strategy can help you maintain the discipline required to achieve your end goals. It can also help you avoid the distractions posed by stories of investors making large returns or experiencing sudden losses. Review your strategy’s performance on a regular basis, but remember the importance of patience and consistency—long-term strategies, especially, can take time to see gains!
Consider using a demo account to implement an investment strategy, without the risk. Utilize virtual funds to try out new strategies and ideas before committing real money to a trade.
Final thoughts
Whatever your financial aims may be, developing a clear strategy is one of the best ways to achieve them. Your overall strategy can involve running different individual strategies simultaneously and engaging in portfolio diversification.
The relative performance of these different approaches can counteract each other, meaning that as one goes down in value, the other goes up. This can lead to smoother overall returns and make it easier to stick with your long-term plan.
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FAQs
- What is the difference between investing and trading?
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Trading typically involves taking positions in assets to try and profit from short-term price movements, while investors usually adopt a longer investment time horizon. Investment strategies are designed to account for the fact that markets can experience both upward and downward trends, and although short-term fluctuations may look enticing, a long-term perspective is less unpredictable and can still pay off in the end.
- How can I test a new strategy?
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Using a demo account is a risk-free way of testing a new strategy. These accounts allow you to simulate trading using virtual funds and real-life market prices. Nonetheless, even if your strategy shows promising results in the demo environment, it is advisable to first begin implementing it on a live account with relatively small amounts of capital.
- What is a “paradigm shift”?
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A paradigm shift refers to a significant and fundamental change in an underlying economy or financial market. Such shifts can be bad news for investors, as they might lead to their strategy failing. Differentiating between a paradigm shift and regular market fluctuations can be challenging, and investors are often faced with a dilemma as to whether to change their strategy or stick with it.
This communication is for information and education purposes only and should not be taken as investment advice, a personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments.
This material has been prepared without taking into account any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or a packaged investment product are not, and should not be taken as, a reliable indicator of future results.
eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication.