Traders and investors seeking profits from share markets face the task of sifting through a large number of technical and fundamental indicators that can be used to assist in trade selection. These indicators typically have the purpose of providing information that will give a trader the winning edge. However, having too many indicators to choose from is as problematic as having too little information to work with. Therefore, an investor ideally wants to select a trading style and then identify a suite of trading tools that 1) reduce the workload involved in finding trade opportunities and 2) produce profits by selecting winning trades.
The aim is to reduce uncertainty and thus reduce trade anxiety that is associated with stock trading. Reducing uncertainty can be translated into having confidence that the stock selection process results in more winners than losers and greater profits than losses per trade. To achieve this means deigning and testing a trading strategy that, when tested historically, proves to be profitable. That is the task. It is not an insignificant investment in time and energy to reduce the huge array of technical and fundamental indicators that are available to a small efficient suite of tools that can be used in a profitable trading strategy. For instance there are more than 50 fundamental indicators out there, not to mention the raft of technical indicators available in software packages these days.
The discussion in this post was motivated by a 2015 American Journal of Marketing Research Article[1] Titled The Selection of Winning Stocks Using Principal Component Analysis. The aim of the research was to find out if the more than 50 fundamental indicators available to investors could be reduced to a more manageable short list. To test this idea, the researchers chose a starting popular-short-list of 22 out of the 50 fundamental indicators for their analysis.
The analysis conducted at the University of Singapore then identified that just 4 of the 22 indicators were needed to identify winning trades. These indicators were Return on Investment (ROI), Return on Equity (ROE), Book Value per Share (Bv/S) and Revenue per Share (RPS). These four indicators were then further grouped into just 2 measures. These were 1) Effective Management which contained ROI and ROE and 2) Share Value which contained Book Value and Revenue per Share. These two groups accounted for 94.27% of the influence of the 22 original fundamental indicators on trade outcomes.
The researchers then carried out by paper trading using Australian (ASX) Health Sector stocks. The aim being to test the profitability of the indicators they had chosen. The stocks to be traded were selected using the Effective Management and Share Value scores. Stocks were traded over three consecutive one month periods (Jan to March 2015) and achieved a ROI of 11.38%, 15.36% and 13.12%. In other words, a positive return was achieved in three separate trading periods for stocks selected using the researcher’s two criteria.
