Investing For Profits, Part 3 - The Basics of the Formulaic Or Quantitative Investing Approach

Are you using the "buy & hold" or the "traditional asset allocation" approach to investing? Do you realize that both of them can put your money at considerable risk for loss -- while not even maximizing its growth potential? Read on for an alternative that's safer and has the potential of far better returns.

That safer approach is much less well-known, yet it is one of the key approaches of the wealthy. It goes by a variety of names, including "formulaic investing" and "quantitative investing." These are not so much official terms but refer to a specific methodology that is employed to get the best possible results.

Let's look at the basic principles behind quantitative investing. Advisors employing that methodology tend to start with a top-down approach, where they take a look at equities in large caps, small caps, and international caps, among others, to get a sense of the broad indicators, via mathematical algorithms.

Then, they use a computer to analyze the various stocks, and find the 10 to 15 individual stocks from each of these categories that have the best potential.

But that's just part of it. Another crucial part is the decision whether it's a smart move to be in equities in the first place. This is decided with the help of something called recession probability analytics.

Recession probability analytics takes various indices in the market place and ranks as well as evaluates them. It takes for example retail sales results, the unemployment rate, the housing market, the discrepancy between the European currencies and the dollar, and more. The computer then uses a point system to evaluate the results.

And the results boil down to answering the question whether it's a good idea to be in equities right now or not. If the result is at 50% or above, it indicates that great caution is appropriate. In fact, the higher the number, the less good of an idea it is to be in the market. If, on the other hand, the results are below 50 percent, the market is the place to be.

The beauty of such a system is that it can tell those who use it to get out of the market when the indicators suggest the strong possibility of a recession. And doing that can cut potential losses dramatically. It even does it all without getting their emotions involved.

What do they do with the money in that case? They hold it in cash. That way, they may not make money, but they also won't lose any money. And once the indicators say it's time to get back into the market, the cash holdings can be put to work right away. Are you using the "buy & hold" or the "traditional asset allocation" approach to investing? Do you realize that both of them can put your money at considerable risk for loss -- while not even maximizing its growth potential? Read on for an alternative that's safer and has the potential of far better returns.

That safer approach is much less well-known, yet it is one of the key approaches of the wealthy. It goes by a variety of names, including "formulaic investing" and "quantitative investing." These are not so much official terms but refer to a specific methodology that is employed to get the best possible results.

Let's look at the basic principles behind quantitative investing. Advisors employing that methodology tend to start with a top-down approach, where they take a look at equities in large caps, small caps, and international caps, among others, to get a sense of the broad indicators, via mathematical algorithms.

Then, they use a computer to analyze the various stocks, and find the 10 to 15 individual stocks from each of these categories that have the best potential.

But that's just part of it. Another crucial part is the decision whether it's a smart move to be in equities in the first place. This is decided with the help of something called recession probability analytics.

Recession probability analytics takes various indices in the market place and ranks as well as evaluates them. It takes for example retail sales results, the unemployment rate, the housing market, the discrepancy between the European currencies and the dollar, and more. The computer then uses a point system to evaluate the results.

And the results boil down to answering the question whether it's a good idea to be in equities right now or not. If the result is at 50% or above, it indicates that great caution is appropriate. In fact, the higher the number, the less good of an idea it is to be in the market. If, on the other hand, the results are below 50 percent, the market is the place to be.

The beauty of such a system is that it can tell those who use it to get out of the market when the indicators suggest the strong possibility of a recession. And doing that can cut potential losses dramatically. It even does it all without getting their emotions involved.

What do they do with the money in that case? They hold it in cash. That way, they may not make money, but they also won't lose any money. And once the indicators say it's time to get back into the market, the cash holdings can be put to work right away.