What exactly does a stock market formula do? Stock traders have been using and developing formulas since the birth of the stock market. A summary of a formula's usefulness includes two main functions that it fulfills.

First, over a full stock market cycle, it will improve your investment profits without the application of any thought whatever on your part. As is well known, there are many investors who do not believe that the market will ever go through a full cycle again -- that the direction of the market is in a permanently upward movement, except for temporary, minor dips. It might be worthwhile to point out, without seeming to be too pessimistic, that there are some good arguments against an indefinite continuation of bull markets.

The second purpose of a formula -- apart from the question of profiting from complete market cycles -- is to provide a means of profiting from more minor fluctuations. It is undeniable that the market will continue to fluctuate, and a formula allows the investor to benefit from these fluctuations by specifying conservative investment policies when the market is relatively high, and more aggressive policies when it is relatively low.

Since formulas ordinarily appear rather complicated, can the small investor profitably use them? The answer is definitely yes.

Some formulas are complicated, it is true, and you will undoubtedly find some that are so complex as to be unsuitable for most investors. But most formulas do not fall into this category. The most widely used formulas today, in fact, are based on extremely simple principles and can be used by anyone with a rough knowledge of grade-school arithmetic. Special measures to adapt formulas to the needs of small investors will need to be investigated, but it is worth noting that small investors are just as likely to want to improve their profit performance in the market as are larger investors, and there is no particular disadvantage in having a small portfolio when you use a formula.

All investors -- large, small and medium-size -- are in the same basic quandary. They would like to be sure of what is going to happen to their capital, and so are inclined to appreciate the features of fixed-income investments such as savings accounts, bonds and commercial paper.

In such investments, their capital is guaranteed, and (except in the case of savings accounts) so is their interest. On the other hand, there are few opportunities for appreciable profits in these areas, and no protection against a decline in the value of the dollar. Consequently, they are attracted by the characteristics of common stocks, where neither their capital nor their return is guaranteed, but which offer substantial opportunities for profits through capital gain.

How to resolve the dilemma? It is obvious that the great difficulty with the stock market is its uncertainty. One workable suggestion of reducing the damage this uncertainty can do has been often made: don't buy common stocks at all. Most investors tend to regard this idea as, although practical, rather extreme, and are reluctant to abandon the possibilities of profit that exist in common stocks.

The formula idea is simply a form of protection against uncertainty. Formulas are designed to allow the investor to profit from the advantages of owning common stocks, while providing a measure of protection against their handicaps; to give some of the stability offered by fixed income investments, while not condemning the investor to a low return on their money. The whole point of formulas is to make the best of both these worlds.