Investing in companies with strong profitability, low debt, and stable earnings—known as the quality factor—offers a systematic way to capture long-term equity outperformance. This beginner-friendly approach helps filter out weaker businesses, aiming for better risk-adjusted returns and fewer painful drawdowns.
| Field | Value |
|---|---|
| Market | Stocks |
| Timeframe | Daily, Weekly |
| Indicators | ROE, Debt/Equity, Earnings Variability, Price above 200 SMA |
| Style | Factor investing, Trend-following |
| Skill level | Beginner |
| Typical holding time | Swing (weeks–months) |
| Risk per trade | 0.5–1% |
- Screen for stocks ranking in top 30% by Return on Equity (ROE) and Earnings per Share (EPS) growth over 5 years.
- Filter out companies with Debt/Equity above 1.0 and excessive earnings volatility.
- Trade only if price is above 200-day SMA (to avoid downtrends).
- Rebalance portfolio every quarter or semi-annually for fresh high-quality candidates.
- Apply diversification to reduce exposure to any one stock or industry.
The strategy’s edge exists due to investors’ historical tendency to dismiss “boring” but consistent businesses. These stocks often outperform in bear markets, thanks to strong balance sheets and reliable earnings. The approach works best during macro uncertainty and trending bull markets, where quality companies show resilience.
Setup:
- Screen: Use a fundamental screener to select stocks with ROE > 15%, positive EPS growth (5yr average > 7%), and Debt/Equity < 1.0.
- Volatility filter: Exclude if last 3-year earnings standard deviation exceeds 30% of mean EPS.
- Momentum filter: Stock price must be above its 200-day SMA.
- Sectors: Diversify by capping each sector at 20% of portfolio weight.
Entry:
- Enter at next daily closing price after screen (market order) or set limit within 1% of close if using a rebalance date.
Stop-loss:
- Set stop-loss 15% below entry price, or below recent 3-month swing low, whichever is tighter.
Take profit:
- Initial target: 2x risk; consider trailing stop once up 1.5x risk. Sell fully if ROE, EPS, or momentum signal violated at next rebalance.
Trade management:
- Once price reaches +8% above entry, shift stop-loss to breakeven.
- Scale out 50% if price extends 30% above entry, hold rest or trail with 50-day SMA.
Indicator settings:
- ROE: trailing 12 months, percentile rank vs. universe
- EPS growth: 5-year annualized
- Debt/Equity: most recent fiscal year
- 200-day SMA: price-based; 50-day SMA for trade management
Timeframes tested:
- Daily and weekly charts for signals
Assets tested:
- S&P 500, MSCI World, US large- and mid-cap equities
Session/Hours:
- US regular session (9:30 am – 4:00 pm ET)
Works best:
- During trending bull markets and during flight-to-quality phases after corrections
- When macro news causes investor risk aversion
- Low credit risk, stable economic backdrop
➡ IMAGE 4: The “Good” Market
Essential. Priority is to display a chart screenshot showing a clear uptrend in large-cap stocks. Mark successful entries where the quality filter would have triggered, with exits holding through minor drawdowns. This visually teaches the reader to spot ideal conditions for the approach.
Essential. Priority is to display a chart screenshot showing a clear uptrend in large-cap stocks. Mark successful entries where the quality filter would have triggered, with exits holding through minor drawdowns. This visually teaches the reader to spot ideal conditions for the approach.
Struggles:
- In choppy, non-trending or crash periods (high volatility, indiscriminate selling)
- During “junk rallies”—cyclical rebounds led by low-quality stocks
Filters to avoid bad conditions:
- Skip major macro event weeks (Fed meetings, earnings season)
- Exclude stocks with ATR (Annualized True Range) above 2x sector median
- Optionally, add a relative strength filter vs. benchmark (e.g., SPY)
- Position sizing: 0.5–1% capital risked per position
- Max open risk: ≤2% capital total at risk at once
- Daily loss limit: Cease new entries following 2R (twice initial risk) losses in a rolling week
- Fees/slippage note: Use low-commission brokers or direct access platforms; rebalance frequency increases costs
Example Trade (Walkthrough):
- Pair/Asset: AAPL (Apple Inc.)
- Timeframe: Daily
- Setup snapshot: ROE = 27%, 5y EPS growth = 12%, Debt/Equity = 0.65, Price above 200-SMA, sector = Technology (<20% allocation)
- Entry: Buy at next day close, $170, after screen confirmation
- Stop-loss: $145 (15% below), also near prior 3-month swing low
- Take profit: $200 (2x risk above entry); consider trailing stop if above $185
- Outcome: After two months, price reaches $210; 1R scaleout at $185 (50% position), remainder trailed to $200. Net: ~2.1R overall. Lesson: Quality filter kept position through sector drawdown, exited systematically.
IMAGE: Example Trade Chart
Display an annotated AAPL chart with price, 200-SMA, entry, stop, scale-out, and exit highlighted.
Display an annotated AAPL chart with price, 200-SMA, entry, stop, scale-out, and exit highlighted.
Pros:
- Simple, repeatable fundamental rules
- Protection against major drawdowns
- Often outperforms in turbulent markets
- Broadly applicable to diversified portfolios
Cons:
- May lag aggressive “junk rallies” or tech bubbles
- Periodic false signals during regime changes
- Misses some early-stage growth/turnaround stories
Common Mistakes:
- Chasing price above signal (not waiting for close or rebalance)
- Moving stop-losses too close to price action
- Over-exposure to a single sector (e.g., Tech in bull markets)
- Trading during earnings or macro news—high surprise risk
Tips and Variations:
- Add a 100-day SMA filter for stronger trend confirmation
- Use ATR-based position sizing to adjust for stock volatility
- Combine with value or momentum factors for multi-factor edge
- Setup automated portfolio screeners to streamline process
- Stagger entry dates (e.g., every two weeks) to smooth timing risk
Tools You Can Use:
- Charting: TradingView, Finviz, StockCharts
- Screeners/Alerts: Finviz, Yahoo Finance, Portfolio123
- Journaling: TraderVue, Edgewonk, Google Sheets
- Backtesting: Portfolio123, QuantConnect, Excel
FAQs:
- Does it work on crypto? Not directly—most cryptos lack stable earnings or ROE data.
- What timeframe is best? Daily and weekly; short-term noise can invalidate the quality signal on intraday charts.
- What win rate to expect? Expect 50–60% win rate, with small losers and large winners driving edge over time.
- Can I automate it? Yes; most fund/portfolio screeners and broker APIs can run systematic filters and execute rebalances automatically.
Glossary:
- EMA: Exponential Moving Average, a trend indicator that gives more weight to recent prices.
- ATR: Average True Range, a volatility measure.
- R-multiple: Profit/loss measured relative to initial risk (distance between entry and stop).
- Drawdown: Peak-to-trough decline during a specific period for an asset or strategy.
Disclaimer: Educational only. Not financial advice. Past performance ≠ future results.