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There are a variety of investment styles. Some of which is not good for you. We will discuss several here, and hopefully help you spot some bad habits and fix them.
Growth oriented vs. value oriented
Growth-oriented investors go after companies that are growing rapidly. Tech, bio-tech, pharmaceuticals, etc are recent favorites. They are going for "potential", "future growth". As a result, they tend to concentrate on small caps and mid caps.
Value-oriented investors go after companies that are underappreciated, or just suffered some bad news, and their stocks are low, but the fundamentals are sound, just temporarily out of favor. They are after "bargain". As a result, they go after mid cap and large cap companies.
The two are not mutually exclusive, but they are two fundamentally different philosophies.
Technically speaking, growth-oriented investing is riskier than value-oriented investing due to its concentration on the smaller end of the stock market. You need to be VERY CAREFUL and VERY AGILE in getting your money out of the bad companies, and shifting them to the good ones. In other words, it'd be a full-time job, or at least take up several hours each day.
You CAN make money this way, but it is NOT recommended for a new investor or a part-time investor. One example: Andrew C. Stephens of Artisan Mid Cap fund turned over 200-250 percent of his portfolio every year from 1998 to 2000, but he was able to get 36.85% gain in 1999, and 45.09% gain in 2000. On the other hand, he gets PAID big bucks for making all these trades... it's his job as fund manager.
If you are a part-time investor or a new investor, you should be in the value-oriented investing camp. Return will be smaller, but steadier. In other words, trade like Warren Buffet: buy big caps that are undervalued, then held on to them forever. Warren Buffet's favorite stocks, what he call his "permanent holdings", includes Coca-Cola, Capital Cities/ABC, and Washington Post Media Group. In other words, these companies produce stuff that people need FOREVER.
Value-oriented investing is less risky as they concentrate on the big caps, who are far less likely to go out of business or suffer sudden humongous bad news. Being big caps, they are likely large companies who has diversified their risk profile across multiple markets (or even continents). In fact, you can often do what Warren Buffet does: just let it sit there, and enjoy steady growth and dividends year after year. What you give up is a chance for them to grow like 1000% in a few years.
If you are new, you should start with 100% of your investing funds in value-oriented investing. Once you've produced some good results (leave it alone!) say over a year or two, you can start thinking about diverting a little bit of the fund, say, 5% to test your skills at growth-oriented investing. If you enjoy that sort of trading, slowly shift your portfolio to 75% value, 25% growth.
Most average investors should stop there. If you really find that you have a knack for this, then feel free to adjust your proportions, but if you want a mostly hands-off approach, you should stick with value-oriented investing.
Momentum investing vs. buy-and-hold
Momentum investing is basically investing on market momentum, trying to time the highs and the lows. Get in just as the stock enters the up surge, and get out when the stock reached its peak and starts to come back down. In a way, it is a lot like growth-oriented investing: constantly shift money around from one stock to another. It takes a short term view of the market. "Buy what's hot" is their motto. it doesn't matter what the stock is.
Momentum trading is risky as you may just miss the trend. If you get in late, the prices you pay are not worth it, and if you get out too early you don't fully realize the profit. If you get out too late, you risk losing everything you gained. And that's assuming you're on the right stock.
Momentum trading requires a lot of knowledge and market timing. It is an advanced technique, college level course, while most investors are barely out of kindergarten. Again, NOT recommended for the new or part-time investor.
Buy-and-Hold is actually strategy used by the value-oriented investing, esp. Warren Buffet (and his mentor, Benjamin Graham). We've already gone over that before, so I won't repeat it here, except a Buffet quote: "If you can't hold it for 10 years, you shouldn't even hold it for 10 minutes."
fundamental vs. technical
Fundamental trading is looking at a company's fundamentals: assets, earnings, stock price, and so on, and determine whether to invest or not.
Technical trading, on the other hand, is about timing the market, reading the supposedly "signals" or "patterns" that the stock price movements supposedly give before they turn, and use that to determine when to buy and sell.
Technically there's a third type... called "no clue trading". Bascially, the investor has no clue, no reason, except his or her whim, on what to buy and what to sell. Could be someone's "hot tip", or what's hawked on TV by some analyst, or a news blurb, or "it looks good".
Unfortunately, most new investors tend to fall into the "no clue" camp. They thought they were picking logically, but in reality their picks are not based on any logical criteria. You don't want to be in this camp. This is how money is LOST on the stock market. Unless you're lucky and bought a growing stock, that is.
Technical trading is quite difficult, as it requires paying constant attention to the signals. With THOUSANDS, MILLIONS of stocks on the market, it is not possible to be analyzing all of them for signals to buy in, even with help of a computer. If you have a portfolio, you can look for sell out signs, but you could just as easily give "stop-loss" orders. Technical trading also fits better with the momentum trading and growth-oriented investing philosophies.
Fundamental trading is somewhat easier as there are only so many numbers you need to look at, instead of looking at the chart and trying to decipher the "signals" within all the noise. Thus, it fits better with the buy-and-hold and value-oreinted investing philosopies. But there are room to be multi-faceted. Most investment houses use fundamental trading techniques to pick which stocks to invest in, but use technical trading techniques to determine when to get in and get out. You should do the same, unless you subscribe to the value-oriented investing philosophy, in which case it's buy-and-hold.
Patience vs. nervous jitter
New investors often have a problem of holding onto stocks. They were taught that you need "movement" to profit from stocks. Thus, if a stock don't move for several days, they want to get rid of it, even if they were told (or previously calculated) that this stock is undervalued and will go up soon. Either that, or they suffer "buyer's remorse", and want to get rid of the stock.
There is also the Wall Street saying "You can't go broke taking a profit". In other words, as long as you came out positive, it's a good deal. But is it really? Considering that even discount traders charge you for every trade, if you trade too much, the commission will destroy your profits, if any.
James B. Cloonan, chairman of the Ameican Association of Individual Investors, recommended that you keep a virtual portfolio of stocks that you "could have held". Put in the # of shares and the price you sold at as the "buy price". Track that for a few months or a year, and see how your alternate portfolio did vs. your real portfolio. Which one did better?
You have to keep in mind that the entire Wall Street and Financial Market WANT you to trade often.
* your broker gets paid PER TRADE, regular or discount broker, doesn't matter. You pay to buy, and you pay to sell. Whether you make a profit or not is not their problem.
* people tend toward small-cap, because that is what they can afford, and that is where they see the "homerun" is, thus, "momentum investing" again
* people focus on the short-term results, not the long-term outlook. It's the "instant gratification" mentality at work, again, "momentum investing"
* people trade stocks as if they are gambling, double-down on previous winners. Which leads them toward "momentum trading" style
* people lack confidence in their stock picks, esp. when they bought it without doing fundamental research of the company, thus the quick sell, momentum investing
* the analysts have to have SOMETHING to do, and news have to have something to report. Reporting stuff justifies their jobs and salary, even if stuff is as mundane as a list of "biggest movers"
* media highlights high-growth companies, which fits with the higher-risk growth-oriented investing, but not value-oriented investing
* media bombards you with news, but more bad news than good, which causes panic, esp. after repeated exposure.
If you tell a homeowner every day what his property is worth, and it started going down, do you think he may panic one day and sell? What if you only tell him once a year?
Thus, the media and the market want you to do momentum investing, which is why you may want to do the exact opposite.
Investing vs. gambling
Most people who think of themselves as investors are actually gamblers, at least in the stock market. Why? They have no strategy, no goal, and made no attempt to learn about the market. (other than: "make money")
Think about it: is there a minimum level of competency required to invest? No. Is there any sort of "safety net" for investing? Very little. Can you get insurance for investments? Of course not! Yet every year, THOUSANDS of stock market rookies join in, knowing nothing about the market, have NO safety-net, and invest in momentum trading, which is fundamentally risky. And of course, they blame the stock market for being risky. They don't see themselves as the risk. They are gambling, not investing.
And don't you do the same.