The Stock Market

stock market strategies

The stock market is a multifaceted arena but has three main sub-categories.

Most investors can find a form of stock market investment to suit their personality type. Conservative people will often confine their investments to so-called 'blue chip' stocks, while day traders who buy and sell penny stocks operate at the other end of the spectrum.

In Australia, the first group is often referred to as 'mum and dad investors', while the second is disparagingly labeled 'mug punters'.

Both strategies can be viable if they are applied with knowledge and skill.

Here are the three main categories of stock market investment:

1. Buy and Hold
  • The key things you need to know are:

  • A share is a certificate denoting part ownership in the stock of a publicly listed corporation. The percentage of ownership is dependent on the number of shares issued by the company. If you purchase 1,000 shares of a company that has 1,000,000 shares on issue, you now own .1% of that company.

  • The stock market determines the value of each share based on a number of factors, including the state of the economy, the company's financial health, and the combined emotional states of the participating investors and traders. The last factor, although less rationally based, can override the other two.

  • Most people who use the buy and hold strategy invest in blue chip companies. These are the more stable companies with the highest market capitalization, a figure comprised of the total value of their shares. In the US, blue chips would include the 30 companies that comprise the Dow Jones Industrial Average, as well as the companies in the S&P 500. In Australia, the ASX 200 are the most highly valued stocks.

  • Long-term investing in stable and valuable companies is a passive investment strategy, and is often used in conjunction with one of the more aggressive approaches.

  • Obviously this strategy works best if you invest when prices are low and sell when they are higher.

  • A mutual fund (or managed fund) is a company set up to purchase shares in a variety of listed companies, often in a specific sector such as blue chips, high growth or property. Individual investors buy shares in the mutual fund, and the fund's shares rise or fall in line with the value of the company shares owned by the fund. There are costs involved when both entering and exiting the fund, so these must be deducted from the quoted rate of return to arrive at the actual return on investment (ROI) figure.

  • Mutual funds can be purchased in monthly installments, a method known as dollar cost averaging. This can be used as a form of forced savings. The initial deposit is usually $1,000, with additional amounts starting at $100 per month.

  • Index funds are mutual fund companies that invest in the companies that comprise a particular share price index, such as the S&P 500 or the ASX 200. There are lower entry and exit costs because the fund manager is engaged in less buying and selling of shares than a mutual fund manager. Because the shares purchased bu the index fund are limited to the companies in the S&P or ASX index, the returns will always mirror those of the stock market index itself, less costs. Only a small percentage of mutual fund managers manage to achieve consistently higher returns than the index.

  • Because mutual funds are considered safe long-term investments, they are often recommended by financial planners.

2. Stock Trading
  • Some investors take a short-term approach and buy and sell stocks over shorter periods of time. This practice is known as trading, and people who enter and exit their trades within a 24-hour period are known as day traders. Other traders use longer time frames, ranging from a few days to several months.

  • Obviously this approach to the stock market requires diligent research and ongoing attention to daily price movements and market changes. With the advent of the Internet, traders can buy and sell shares online, purchase live data, read company announcements and do unlimited research. For many, watching the stock market becomes a full-time job. You must decide if your personality is suited to this kind of lifestyle.

3. Derivatives
  • Trading options is another stock market vehicle. A call option gives the buyer the right (but not the obligation) to buy a fixed number of shares in a company at a specified price by a specified date. Similarly, a put option gives the buyer the right (but not the obligation) to sell a fixed number of shares in a company at a specified price by a specified date. Options costs a fraction of the company's share price.

    Options trading can be very lucrative if the trader has truly mastered the concepts, but can spell disaster for the uninformed speculator. You need to complete a well-designed options course and find a reputable options broker to execute your trades.

    If you want to learn more about trading options, Stephen Cooper offers an excellent course on Online Options Trading.

  • Futures trading involves buying and selling contracts on commodities such as wheat, soybeans, gold and silver. Like options, it requires specialized study and a mastering of the concepts involved. One of the legendary U.S. commodities traders of the 20th century was William D. Gann, but his books are difficult to read and often require interpretation.

You'll find that one or more of these approaches will suit your personality more than the others. Take some time to explore your options before you invest your capital.

Analyzing Stocks

There are two methods of assessing stocks:

  • Fundamental analysis is the study of a company's financial statements, in order to discern the fiscal health of the company.

  • Technical analysis is the study of a company's share price movement over time, primarily through the use of charts and a variety of indicators.
If you choose the stock market as a money-making vehicle, you need to master both of these forms of analysis.

You can also investigate margin lending, whereby banks will lend you up to 70% of a share's price towards its purchase. You should only use this form of leverage when you've had some success with your stock market strategies.

Paper trading is the practice of making hypothetical trades on paper to test out a system you're studying. It's a great strategy to practice for at least 3-6 months before you start trading with real dollars.

Your Next Step:
  1. Read Market Wizards and The New Market Wizards by Jack D. Schwager. Both books contain interviews with a number of successful stock market traders, providing perspectives on a variety of wealth creation vehicles. One of these might be exactly what you're looking for.

  2. When you've chosen a stock market vehicle, read at least three books on the subject. For a short list of stock market titles, go to the Financial Resources page.

  3. Invest in a reputable stock market course. If you're interested in trading options, one course we do recommend is Stephen Cooper's excellent Options Trading Online Option Trader

  4. Explore a number of stock market web sites and subscribe to the newsletters of those you find helpful or interesting. Visit our list of Top 10 Stock Market Sites.

  5. Paper trade for for at least three months before you invest your money.

  6. When you're ready to start investing or trading, read the Business Structures.

  7. Find a reputable broker. Get referrals from your friends, business acquaintances or your support team.

  8. Use the wealth mindset techniques to keep control of your emotions.

  9. Visit the Amazon web site to source books on the stock market.