Many young people consider investing as a quick way to get rich. Buy a stock. Watch its price rise, and then, take profits. But perhaps you have tried this and watched your stock price drop. This is a common problem. Smart investors use tried-and-true philosophies and trading methods to have a better chance of buying the right stock at the right price and, hopefully, selling at a nice profit.
Invest Like Warren Buffett
Billionaire Warren Buffett, a famous fundamentalist investor, typically targeted high-quality companies he considered undervalued. When you are just starting to invest, this is good advice to follow. Developing good investing habits at the outset makes investing fun, helps to limit losses and can provide extra money for important things like buying a house and raising children. Use a company's financial ratios such as the price-earnings ratio (stock price divided by earnings per share), return-on-equity (earnings divided by shareholders' equity) and more complicated calculations such as using the present value of expected future cash flow to find a stock's intrinsic value. A proper buy-point would be achieved by waiting until the stocks you are watching become undervalued relative to other companies in their industries. That's when you buy. Add to your position if they become more undervalued, but make sure there hasn't been a deterioration in the company's fundamentals before you buy more stock.
Chartists don't care about company fundamentals. They care about the direction of a stock's latest trading trend. If patience is not your best personal quality and financial analysis bores you, try technical analysis of stock price charts to make your investment decisions. Pick stocks that interest you and look for support and resistance points in their price charts. When a stock trades up through a resistance point, it is a buy signal. When it bounces off a support point, that is another buy signal, but if it trades down through a support point, a sell-signal has been created. This is basic technical analysis for trading. Its philosophy is based on crowd psychology and the supply and demand that shows on charts of a stock's price movement. When there is buying demand for a stock, the price rises. When there are more sellers than buyers, it falls. Investors tend to move like schools of fish. When enough investors buy into a stock at a specific price point, say $10 a share, and it rises to $15, some investors will take profits. Profit-taking sell pressure at $15 drives the stock back down to $10 where the investors who sold at $15 buy back in, expecting the stock price to go up to $15 again. If buying pressure is strong enough, the stock price might rise beyond the resistance point at $15, which is an upside breakout and buy signal. If profit-taking is extensive enough that it drives the stock price back down below support at $10, it is a downside breakout and a sell signal.
Pick Your Price
You might be wrong. You might buy at what you think is a proper price point, only to watch the stock price decline. Trading philosophies are just ways of arriving at a good guess. They don't always work. Try doing some research into the fundamentals of the company behind a stock, or look into recommendations of stock pickers like CNBC's Jim Cramer. Then check to see whether the stock charts show a potential upside breakout before you buy. This method should give you an idea where to begin to scale into your position. This is a good method to use whether you are just looking to day-trade or are investing for more long-term goals such as large purchases, a college fund or retirement.
If you are concerned about buying at too high a price, try making small, regularly scheduled purchases of the stock rather than committing all your money at one time, hoping the stock price rises. This is called scaling-in or dollar-cost-averaging. It accepts that stock price volatility is not easily predicted, and assumes that scaling into a stock over time, as the stock price rises and falls, will result in an average cost that is likely to be better than if you had picked a specific buy point. The success of this method depends on the quality of the stock's underlying company and the general mood of the market. If a strong bear market is in place, all stock prices might be in long-term decline, but if you keep buying as the price declines, when the bull market returns, you should make profits. Again, that depends on the strength of the underlying company and whether its stock participates in the bull market. However, this is a great way to start building an investment portfolio, particularly if you are a beginning investor.
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- Motley Fool: Warren Buffett's Priceless Investment Advice
- U.S. News: Six Keys to Investing Buffett Style
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