Rule based investing strategies can be very effective for beginner investors who are just starting out in the stock market. By following a set of rules, beginners can remove emotion from their investing decisions and build discipline. This article will provide an overview of rule based investing, examples of rules that can be implemented, and stocks that are suitable for novice investors.
Define entry and exit rules for trades
One of the key aspects of rule based investing is defining entry and exit criteria for trades. For example, a beginner could implement a rule to only buy a stock when it pulls back by 5% from a 30-day high. They could then sell when the position gains 15%. Strict rules remove guesswork and force discipline.
Use stop losses to control downside
Another beneficial rule is to use stop loss orders on all positions. This will automatically sell a stock if it drops by a defined percentage, protecting capital from large drawdowns. For instance, a 10% trailing stop loss could be implemented on a position.
Focus on high quality companies
For beginning investors, it can be wise to restrict the investment universe to established, high quality companies. This reduces volatility and risk compared to speculative small caps or penny stocks. Blue chip stocks with wide competitive advantages, steady earnings growth and shareholder friendly management make ideal candidates.
Reinvest dividends to compound returns
Most solid companies pay dividends to shareholders. Reinvesting these dividends through a Dividend Reinvestment Plan (DRIP) allows beginners to steadily compound returns over time. DRIPs automatically use dividends to purchase additional shares commission free.
By implementing rules around entries, exits, stop losses, stock selection and dividend reinvestment, novice investors can remove emotion and guesswork from their investing. This breeds discipline and also reduces risks compared to speculative trading approaches. Following established rules allows beginners to gain confidence and experience before venturing into more advanced strategies.