Stock market is complex, but I will try to simplify it for you today. Buying a piece of security is statement making endeavour, the statement you are making when buying a stock is that you’re right and the market is wrong. Buying a stock means that you know something that the market hasn’t already factored into the current stock price and your insight is better than the market.
Trading in stock is no different from trading any other products. The main reason why anybody would want to engage in a trade is to make a profit or else it’s pointless and a total waste of time, energy and scares resources.
For the sake of simplicity, I will compare trading a stock to getting product from a manufacturer like Nike to sell in an online ecommerce store. Say for example, if you pay Nike $50 to get a pair of Nike, when the same shoe is posted on your store for sale you wouldn’t list it for same for $50, since you want to make a profit, you’ll set the sale price as $80 dollar, which means you’re going to get a $30% profit from the sale of the shoe. Stock market is no different, anytime a stock is bought below it’s intrinsic value, a “Sell Stop Limit” Order should be place to specify at what price the stock should be sold (hedging). For example, if you bought a stock of Uber for $20, you will place a “Sell Stop Limit” Order to sell the stock when the price reached $50 (30% Profit). If you fail to set a sell stop order and a black swan event like Coronavirus happened and the stock market tumbled, you have left 30% profit on the table because it’s not locked-in. My advise is to not to get caught holding the bag because stock is a zero-sum game.
Buying the index is the safest way of playing the stock game. To play it safe especially if you are new to investing. follow warren buffett’s advise and buy the index not individual stocks. However, if you want to become an active trader then my only advise is to focus on growth oriented stocks. Buy a stock and keep if for more than 30 months or longer while the company continues to grow. This means you have to possess the temprament and will to hold on to the stock for a long time (long term). A growth stock is a stock of a company that generates substantial and sustainable positive cash flow and whose revenues and earnings are expected to increase at a faster rate than the average company within the same industry. Growth investors look at five key factors when evaluating stocks: historical and future earnings growth, profit margins, returns on equity, and share price performance. Ultimately, growth investors try to increase their wealth through long- or short-term capital appreciation. Most growth-stock companies reinvest their earnings back into the business, rather than pay a dividend to shareholders. They tend to be small, young, innovative companies (or companies that have just started trading publicly with new technology and services changing the way we live, play and work).
Time is Money
Time is money. Any sum of money payable in the future is worth less than if it is paid today. This is because that sum of money, if paid today, can be put into an interest bearing bank account to earn interest. Holding on to a stock that is underperforming or on a downward spiral is tantamont to throwing money away or throwing good money after bad.
Strenght in Numbers
In Soccer, the purpose of passing is to keep possession of the ball by manoeuvring it on the ground between different players with the objective of advancing it up the playing field. This brings an advantage in that the team secures possession of the ball, without allowing the opposition an opportunity to attack. Moreover, there is strenght in numbers that is why a soccer coach advises his players to pass the ball in a trianglular form instead of trying to dribble 3 to 5 players at once risking the chance of losing the ball. However, if you’re an anomaly like Maradona, Pele or Messi, your coach will let you do your thing because of the magic you possess, but these players are very rare. Same analogy works in stocks, it’s better to buy another stock after a stock made 30% for you than to hold on to the stock thinking it’s going to reach 1000%. Stocks like Amazon, Google are anomalies in the stock market. I know Warren Buffett favored buy and hold, but Warren is not a stock trader anymore, he’s an highly experienced old man and he’s been doing it over 70 years now. Warren Buffett is no longer buying individual stocks, he buys a whole company, take the company out of market and add it to his portfolio because his fund his worth over 500 billion dollars. As a beginner, you’re going to be investing between $500 to $5,000, your strategy cannot be the same as someone that is considered to Oracle of investing.
What Is the Efficient Market Hypothesis (EMH)?
The efficient market hypothesis (EMH), alternatively known as the efficient market theory, is a hypothesis that states that share prices reflect all information and consistent alpha generation is impossible. According to the EMH, stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices. Therefore, it should be impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can obtain higher returns is by purchasing riskier investments.
Proponents of the Efficient Market Hypothesis conclude that, because of the randomness of the market, investors could do better by investing in a low-cost, passive portfolio.
Data compiled by Morningstar Inc., in its June 2019 Active/Passive Barometer study, supports the EMH. Morningstar compared active managers’ returns in all categories against a composite made of related index funds and exchange-traded funds (ETFs). The study found that over a 10 year period beginning June 2019, only 23% of active managers were able to outperform their passive peers. Better success rates were found in foreign equity funds and bond funds. Lower success rates were found in US large cap funds. In general, investors have fared better by investing in low-cost index funds or ETFs.
While a percentage of active managers do outperform passive funds at some point, the challenge for investors is being able to identify which ones will do so over the long-term. Less than 25 percent of the top-performing active managers can consistently outperform their passive manager counterparts over time.
In a nutshell, invest in what you know and what you’re an expert at!