How to Use Math to Gain Success in Stock Trading

Learn how to use math to predict future price movements.

Stock trading is extremely difficult due to the fact the market is a zero sum game: in order for a trader to have a capital gain another trader must have a capital loss. Hundreds of different trading styles exist. Two main categories of trading styles are fundamental and technical analysis. Fundamental analysis relies on evaluating the company's earning, management and other intrinsic indicators of the company's value. In contrast, technical analysis relies on evaluating the chart of the company to predict future price movements. Fundamental and technical strategies involve math. Although math strategies that simply involve using equations for prices of when to buy and sell exist, many math strategies rely on analyzing the math in order to make trading decisions.

Instructions

1. Go to your local library to check out books about math trading strategies. Dozens of books discuss how to use math to help predict future price movements. Even books such as "An American Hedge Fund" and "How To Make Money In Stocks" have portions where the author discusses strategies which involve using math to analyze the movement of securities. In addition, check out several books about famous traders, such as Jesse Livermore and Timothy Sykes. Although these traders primarily used other forms of analysis to predict the movement of stocks, they did use math to gain an advantage in the stock market. Furthermore, learning the psychology of these traders described in their books may assist you in developing your own math strategy.

2. Evaluate the price barriers of stocks you would like to trade. A price barrier is a price on a chart that the stock is unable to go above or below. Keep in mind different chart time-frames might reveal different price barriers. For example, if on a weekly chart a stock comes close to $15 multiple times but never is able to go above $15, then $15 is a key price barrier for a weekly chart. However, if a monthly chart shows that the stock did break above $15 multiple times but could never surpass $16, then $16 is a key price barrier. Calculate the difference between the price barrier and the current stock price through subtracting the price of the price barrier by the current price of the stock. If the difference is small, consider investing in the stock based on past performance. If the stock has never been able to break above the price barrier, then consider short-selling the stock. Short-selling is the act of borrowing shares from a broker in order to sell the shares then buy the stock back at a lower price to reimburse the broker. However, if the stock has been able to break past the price barrier in the past, consider buying the stock.

3. Calculate the price-earning (P/E) ratio of the stock. This is done through researching the earnings-per-share of the past four quarterly earning reports, then adding the four together to create an annualized sum. Next divide the current price of the stock by this annualized sum. The result is the P/E ratio of the stock. If your broker does not provide quarterly earnings information, many free websites offer this information, such as Yahoo! Finance. Evaluate the P/E ratio of other companies within the company's sectors to assess whether the stock is outperforming or underperforming. If the P/E ratio of the stock is high, then investors are expecting future growth of the company. On the other hand if the P/E ratio of the stock is low, then investors are expecting the company to decline.

References

• Investopedia: Price-Earnings Ratio---P/E Ratio

Resources

• Yahoo Finance