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Introduction:

The following is for informational purposes only. It is not legal, financial, or other advice. Any actions you take or refrain from taking are done so at your own risk.

Did you ever wonder how much money you could make in the stock market if only you knew the future? I did, and that is why I developed this new stock trading system from scratch. For lack of a better name, I will call this system “Exponential Stock Trading,” or ExST. This article will describe how and why this system works.

Picking a Baseline:

First, let us look at an example of predicting the future. Imagine that you are driving down the road, and notice the car in front of you is starting to slow down just before an exit. It is usually a good sign that the car will exit the highway, even if they do not use their turn signal. The reason that prediction works is because we established a baseline – the speed the car was traveling. Then, we compared the car’s speed to that baseline. To be successful in stock trading we first need to establish a baseline.

The ExST system attempts to use a baseline of the actual value of a company. So, what exactly is the value of a publicly traded company? Some people might say that it is the number of shares multiplied by the price of the stock. That is the value investors believe the company is worth. However, that is not the “actual” value of a company that I am talking about. The value investors think the company is worth fluctuates from day to day, sometimes by a very large amount. Those fluctuations are fueled by speculation on the actual value of the company. Did the actual value of the company fluctuate that much? It is not very likely. The actual value of a company will most likely change very slowly over time, at least much more slowly than the fluctuations in the stock market. This leads to the first step in the ExST system.

Although it is not a 100% foolproof method, the ExST system uses an average of the historic stock prices. The most popular averaging is called a simple average. We do not want to use a simple average because it is always lagging. We need to use something that is not lagging – the exponential moving average. This will provide us with a very nice baseline that predicts buy and sell points faster than other trading systems. We will be subtracting this baseline from the daily prices of a stock to produce a graph showing only the fluctuations as a percentage. This is the first and biggest piece of the puzzle.

A Comparison of Averages:

The Fluctuation Graph:

Now that we have a fluctuation graph, it is very easy to see low and high points to buy and sell. In fact, a very conservative method to trade would be to draw a line across the 90 and 100 percent marks. If the stock dips below 90%, then buy and hold it until it goes above the 100% mark.

Putting Them Together:

If only it were as easy as just looking at the fluctuation graph. In reality, we need to learn how the fluctuation graph corresponds to the stock price graph. So, how does this system perform? Surprisingly well. In fact, the system is right more than it is wrong for most stocks, which is a great starting place for a stock trading system. Some people may stop there, but there is one more layer to the ExST system.

The Betting Layer:

It is not a good thing when a trading system picks a bad time to buy. Imagine if there was some way to turn those bad events into good events. There is a way, but it is risky, and some people may not want to take the risk. The final layer to the ExST system is a betting layer. Since the system is right more than it is wrong, we bet against the bad picks by purchasing double the initial purchase price of the stock. In other words, if the ExST system picks a time to buy, and the stock price continues to fall, we buy more – twice as much. For example, if PHG is sitting at $22 a share, and the system flags that price as a buy, we would buy $500. Later, if the price falls to $20 – a 10% loss – we would purchase $1,000 more. When the stock finally does goes back up, we sell and take a bigger profit. So now that you understand how the system works, it is time to cover its limitations.

Limitations and Warnings:

The first limitation was just mentioned – the betting layer. If the system is wrong too many times, there will not be sufficient funds to buy more stock when required.

Another limitation is the company size. Some companies are so small that it may not be possible to sell the stock rapidly enough before the stock price starts to drops. This will exclude most, if not all, penny stocks. Similarly, some very large companies’ stock prices do not fluctuate enough to trigger buy and sell points. This system works best on stocks in the middle of those two extremes.

The final limitation is like most trading systems: It does not work in a steep stock (or market) downturn. Limitations to the system are not the only thing to watch. There are some warnings too.

One warning is for companies that have high volatility. It is easy to change the buy and sell points in the ExST system, but one has to be careful because they can easily make the system appear to be very successful on every stock. The buy and sell points should be set very conservatively, and not constantly tweaked.

Another warning is placing the buy and sell lines on the fluctuation graph too close together. If they are placed too close together, then money will be lost in stock broker commissions, and a lot more work will be needed on the part of the trader.

Using the Spreadsheet:

To test the ExST system, I created a spreadsheet in Excel. You can find links to download it at the bottom of this post. There is a section of colored boxes that allows you to configure different parameters of the system.

The first section is called “Setup.” There is a box where you can enter the stock ticker. The spreadsheet does not use that in any way – it is just for the user’s convenience. The next box is the weighting of the average. The smaller the number, the sharper and smaller the spikes in the fluctuation graph become. For larger companies, the user may want to increase this amount from the default of three. The next box is the upper limit. This tells the system when to sell a stock. A conservative number for this is 100%, which will allow for success during a slight bearish trend. The next box is the lower limit. This tells the system when to buy a stock. A conservative number that works well for most stocks is 90%. The final box in this section is the amount of money the user will buy for their first purchase.

The next section is called “Stock Broker.” There is only one box the user can enter information into. It is the cost of a stock trade. This will be different for each broker. Some brokers charge a percentage on top of commission for a trade. This spreadsheet does not calculate that in its present form. The next box tells how many trades were made on the stock graph. The final box in this section tells how much money will be paid to the stock broker.

The next section is called “Trading Statistics.” It gives a lot of details about how successful, or unsuccessful, the ExST system was. The first box shows how many days the stock was held. The next shows the peak investment which is the maximum investment the user would have made during the time displayed in the graph. The next three boxes show some gross numbers, but the user should not focus on them too much, but rather, focus on the next section.

The next section is called “Profit / Loss.” This is where we finally get to see how well the ExST system worked, factoring in the broker commissions. The first box shows how much profit would have been made if the user followed the system during the displayed time period. The next box shows how much interest would have been made assuming the user had an initial sum of money equal to the Peak Investment box. The next box shows how much interest would have been made if the user was able to get the same interest rate in the prior box for a whole year. This number is a bit unrealistic, but I use it to compare different stocks to each other. For example, a stock that has an annual interest rate of 200% is twice as good as a stock with a return of 100%.

The final box shows what activity a user would take if they are following the system. It will tell them when to buy, sell, and wait. It also tells them how many shares to buy when it is time to buy. However, as stated in the disclaimer, this is not financial advice. I recommend using play money.

So, there you have it. I am sure a lot of people will have fun with the ExST system.

Downloads:

You may download a copy of one or more of these spreadsheets, but you may not distribute them to anybody else or copy them to location where the public can access them. If somebody else wants a copy, do not link directly to these files – link to this page.

• Apple Numbers: Click here to download.
• Microsoft Excel 2007: Click here to download.