Active Trading vs. Long-Term Investing
When most beginning investors think of the stock market, they think of the fast-paced buying and selling of stocks to make quick profits. While trading (transferring assets, such as stocks, to make a profit on the sale) is one way to approach investing, it is not the only way.
Traders generally try to benefit from short-term changes in the market by frequently buying and selling shares based on trends.
Trading can be seen as occupying the opposite end of the spectrum from long-term investing. The goals of most investors will be best met by a more conservative (and less active) approach. But, again, it all comes down to what your goals are.
Before You Pick Stocks
- You need money to invest that does not limit your ability to meet other financial needs.
- You need to be willing to lose some (and very infrequently, all) of that money.
- The riskier the investment, the higher the potential losses and rewards.
Trading (market timing) is very difficult to do. You have to be right twice — once when you buy the stock and again when you sell it. Even professionals with years of experience have a hard time making money this way.
Picking Stocks — An Art, Not a Science
You can experience the excitement of picking stocks and following their progress without the dramatic ups and downs of constant active trading. The most important thing to remember is that there is no magic formula to making money in the stock market. Even the most seasoned investors choose their stock investments using theories or strategies, with varying levels of success, depending on a wide range of factors.
Bulls and Bears
You might have heard the terms bull and bear markets. In the simplest terms, bull means rising and bear means declining.
So, if you are bullish on a certain stock, it means that you believe its value is increasing. If someone says it’s a bear market they mean that the markets are headed downward.
Stock Analysis Methods
Investors rely on different methods for estimating the future value of a stock. Some examples include:
- A method for determining the true (or intrinsic) value of a company by estimating all future profits and adjusting for inflation.
- “Profit” means what is left over after all operating costs have been covered. Keep in mind that profits for the company do not necessarily translate to money in shareholders’ pockets (if your goal is to earn money on dividends). On the other side, if a company consistently delivers high dividends to shareholders, that money is not being reinvested into the company to promote future growth.
- To determine a company's fundamentals, investors examine the company’s past and current cash flow, discounted for inflation, and consider the company’s projected rate of growth.
- This method widens the criteria to include factors beyond earnings that could contribute to a company’s future success or failure — and to the rising or falling price of shares. These factors can include the company’s plans for new products, its current management, potential opportunities or challenges in the company’s industry sector (e.g., technology) and many other aspects that can’t be seen in earnings alone.
- By contrast to other methods, investors who use technical analysis often do not consider the long-term future growth or viability of a company. Often, technical analysts (sometimes called chartists) know very little about a company’s history, management or products because investment decisions are made using charts of past trends to predict future movements, based solely on the chart data.
- Chartists look for specific patterns (or indicators) in chart reports – for example, the “head and shoulders” or the “ascending triangle.” Technical analysts employ a wide variety of patterns to make predictions, but all chart patterns examine the price of a stock over time to identify trends. Successfully spotting these patterns takes practice, and even experienced chartists still must rely on their own subjective opinions.
Two Common Stock-Picking Strategies
The factors that determine whether the stock market or individual stocks go up or down generally cannot be predicted, so investors have developed several strategies for determining what to invest in. Here are just two examples:
- Value Investing involves finding companies that are trading for less than they currently are worth.
- Growth Investing means finding companies that you believe will grow in the near future.
With value investing, you want to find companies that look to be undervalued in the current market. Using your chosen method or combination of methods (such as analyzing fundamentals or qualitative factors) to determine a company’s value, you would choose stocks that seem to be a good bargain at their current price.
Rather than looking for stocks that currently are undervalued, growth investors look for indicators (such as earnings per share and the price-earnings ratio) that a stock will grow in the future. This method can favor new products or growth industries – such as new technologies – that the investor believes will grow.
Before you rush out to buy your first stocks, you will want to do further research into these and other methods on your own or with a financial planner to determine the best approach based on your risk tolerance, timelines and unique investing goals.
A Note On Loss
When you’re just starting out investing, it is important to remember that a loss on paper is different from an actual loss. During the financial crisis of 2008, many investors pulled money out of their investments; however, many other investors waited for the markets to recover and made up some or all of their losses. “Waiting it out” for a loss to recover sometimes is — and sometimes isn’t — the best strategy, based on the fundamentals of the investment. Work with a trusted financial advisor to evaluate your best strategy.