At the time I started day trading (early May, 2009), interest rates were hovering at historic lows and the stock market was riding a two month surge after falling to 10 year lows.
In recent years, I've bought and held income stocks and invested in callable and non-callable
CDs. I've also dabbled in technology stocks for companies that I've worked for in the past. The market interest rate has resulted in the calling of many
CDs, so I found myself in a strong cash position in my Traditional IRA and Roth IRA accounts.
Given this cash, I decided to dust off my old income stock strategy to make it meet my current needs.
The renewed strategy again depends on income stocks, but I've made a number of refinements. I no longer look for the absolute highest payers. The market is littered with recent dividend cuts, and the higher
yields are often at risk. Also, I no longer look for stocks that are going ex-dividend within days. The dividends are still important as a secondary source of income, but capital gains are now the main target.
There are several components to this updated and hopefully improved strategy.
Stock Targeting - First, I needed to find a pool of candidate stocks. Although I'm looking to trade the stocks quite quickly, I want to make sure that I would be comfortable holding them for the long term in case the price does not move in the direction that I wish. I primarily screen based on the following criteria:
- Dividend yield between 3% and 6%
- Payout ratio less than 60%
- P/E Ratio less than 15
- Reasonably high market cap and volume
- Reasonably high analyst ratings/recommendations
Buying Trigger - Now that I have a pool of candidate stocks, I have to decide which ones to buy and when to buy them. Unfortunately, I'm not into technical analysis, so my
approach is more by the seat of my pants. I look at the recent trading range and pick a number at the low end of the range as my target. I hope to become more scientific about setting this number in the future, but right now it's based on my gut. If a stock dips to that price, I buy in. I also eliminate some candidate stocks at this point if the trading range is very narrow. If the price only varies by 1%, it's hard to recognize any
significant short term gains.
Buy-in Amount - I always buy into a stock with approximately the same amount of money so that all holdings are in about equal dollar amounts (except for double downs, see below). I usually try to buy in round lots for convenience even though my broker does not charge a premium for odd-lot trades.
Diversification - There are some industries such as high-tech that will only rarely meet my filtering criteria, And there are others like energy where most companies are buy candidates. so I try to be careful not to be over-represented in a given industry. I try to hold only 1-2 stocks from a given industry at a time even though I might have several on my filtered list. There are also some industries that I avoid entirely because I perceive more risk than I'm willing to bear. This currently includes tobacco products and banking, although I've been tempted by some yields I've seen.
Tax Strategy - My hope is to capture significant short term capital gains, so minimizing taxes is an important consideration. Therefore I use tax deferred accounts as my main investment vehicle while
taxable accounts are used for living expenses. I'll worry about taxes when I take my distributions at some point in the future. Most purchases are made with my Traditional IRAs accounts (where I have greater funds) and I use my Roth IRAs for the investements where I expect the highest yields since these gains won't be subject to future tax (see double downs below).
Sell Trigger - Like the buy trigger, my sell trigger is a bit soft. I usually look for at least a 5% gain, but if the stock is trading in wide range with a lot of valitility, I might set the sell price to be much greater. However, this is subject to reduction if I feel a need to cash out due to fear related to a market or company variable or perhaps I'll cash out early because I see a better use for the funds with another security. As I mentioned before, I don't worry about waiting for a stock to go ex-dividend, but if it does, it's a nice added bonus.
Unlike many day traders, I do not use stop-loss. I don't want to be automatically removed from my position due to market fluctuations. I make an attempt to select strong companies that I'm willing to hold for years. Of course this might mean that I cease to be a trader if the market turns bullish for the long term, but I will continue to be rewared with dividends as long as the individual tocks in my portfolio remain strong.
Double Down - On occasion, my buy target proves to be a bit high and the stock price continues to drop after I buy in. Assuming that the fundamentals of the stock remain strong and I remain confident that it will surge upward, I will use this as an opportunity to buy additional shares at the lower price. When I do this, I use the money from the Roth IRAs for this second position. For example, let's say I originally bought a stock at $20 and planned to sell it at $21 for a $1 profit per share. However, the stock dropped to $19 dollars, so I would buy additional shares via the Roth IRA with an intention of earning $2 per share tax free ($21-$19) on this second purchase.
Cash Management - I actively trade with less than half of my available cash. This allows for ready cash in case the market turns bearish and greater buying opportunities present themselves.
