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Thursday, May 17, 2007Posts in the [Stock Made Simple] series:
Now, you’ve learnt some very basic things about stock. Let me share with you how you can make (or sadly lose) money slowly with it. Please also note that: This post is only an introduction about moneymaking strategies with stock. You should considered some serious education (for example, Wealth Academy or Wealth Academy Trader) before you can use them successfully.
Buy and Hold: The Most Popular Strategy for Investors
The reasoning behind it is that if you buy a stock in a fundamentally sound company and hold it for the long term, you’ll see a profit eventually. If you don’t have time to what the market constantly, you can buy a stock and watch it rise in price. Investors who bought companies like IBM, GE, and Microsoft in the early days made huge sums of money without having to pay much attention to the market. Another advantage is that because you don’t frequently buy and sell stock, you pay very little in brokers’ commissions. Buy and hold is the easiest investment strategy to use. Perhaps the only time buy-and-hold investors sell is if something fundamentally changes in a company. Normally, they don’t sell because of what is happening to the market, the economy, or the stock price. They are focused only on the business, and they intend to hold their reasonably priced stocks as long as possible. Please note that though buy-and-hold is really simple, it’s not as easy to use as people think.
Value Investing: Buying Good-Quality Companies at a Cheap Price
Value investing is very similar to buy-and-hold, but it’s at a higher, well-researched and well-informed level. Value investors primarily use fundamental analysis to pick sound stocks that are a bargain compared to their actual worth (intrinsic value). Often, value investors will buy stocks in companies that other investors don’t want. These are companies whose earnings grow slowly but steadily. Value investors are long-term investors and are willing to wait years for their stocks to become profitable. Actually, Warren Buffet (considered to be world best investor) is a value investor himself.
Buy on the Dip: An Offshoot of Buy and Hold
In this strategy, when a stock you like goes down in price, especially if you believe the decline is only temporary, you buy more shares. The idea is that because the market generally goes up over time, the shares you bought at a lower price will eventually be worth more. The problem with buying on the dip is that stocks sometimes dip two or three times before dropping permanently.
Bottom Fishing: Finding Bargains among Unloved Stocks
If you are a bottom fisher, you look for stocks that are so low that they seem to have hit bottom. Professional bottom fishers are constantly on the lookout for stocks that are so low that they have nowhere to go but up. The danger of bottom fishing is that you never know exactly when the bottom has been reached. Some company will just eventually go out of business. Stocks that are in the basement tend to stay there a while. It could be years before many of these unloved stocks rise in price. Thus, you have to be extremely patient to be a successful bottom fisher.
Dollar-Cost Averaging: A Systematic Stock-Buying Approach
Instead of buying stocks whenever you have extra money in your pocket, with dollar-cost averaging you buy stocks on a regular, systematic basis. You invest a fixed amount of money for each period of time (for example, $100 per month). The beauty of this system is you don’t have to worry about stock price as long as it’s generally going up. The problem is that if your stocks keep dropping, you will be left with substantial losses.
A strategy similar to dollar-cost averaging is called averaging down. With this strategy, instead of investing a fixed amount of money each period, you buy more shares of stock whenever the stock is going down (in an uptrend).
Growth Investing: Buying Growing Companies
In general, growth investors use fundamental analysis to find stocks that are growing faster than the economy or earning more than other stocks in the same industry. They like to see earnings growing by at least 15-20% a year for the next 3-5 years. Most important, these companies’ earnings are growing faster than those of their competitors. Usually, these stocks don’t pay dividends because whatever extra money the company earns is re-invested in the company. Although investing in growth stocks can be risky, the rewards can be tremendous.
An offshoot of growth investing is Growth-At-a-Reasonable-Price (GARP). GARP investors basically combine value and growth investing into one strategy. They are looking for growth stocks, but they are willing to wait until they can get the stocks at a reasonable price.
Momentum Investing: Buy High and Sell Higher
Momentum investors are growth investors who look for stocks that are ready to make explosive moves upward. They buy stocks at a high price but plan to sell them at an even higher price. They don’t care too much about the price they paid as long as the stock goes higher. Momentum investing works best during bull markets when there is a lot of liquidity. Some critics call momentum investing the “greater fool theory,” which means that no matter how high the stock price is, you will always be able to find a bigger fool who is willing to buy it from you. Momentum investors tend to use technical analysis to look for stocks that will make sudden and dramatic moves in a short period.
Momentum investing, although exciting and potentially profitable, is a difficult strategy. Many momentum stocks can explode in either direction, often costing you a lot of money. Although it’s possible to catch some of these stocks on the upside, it is definitely not as easy as it looks. Perhaps you should wait for the next bull market before using a momentum strategy.
Contrarian Investing: Doing the Opposite of Everyone Else
Contrarians, as they call themselves, use fundamental analysis to find high-quality companies that other investors have abandoned. The more unloved the stock, the more contrarian investors like it. Contrarians are especially fascinated by a company that the media and other investors hate. However, it takes a tremendous amount of skill and patience to find formerly high-flying stocks that will once again outperform the market. In addition, it takes courage to buy stocks that no one else wants.
There is also a group of contrarian traders called “investolators” who use technical analysis, especially charts and institutional ownership, to find stock picks. Just like contrarians, investolators look for unloved companies that have hit bottom.
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