I have had many people ask me, “What is a good stock to buy?  I want to start trading like you did in your days as a stock trader.”  I do still trade occasionally, but not at the level as I have in the past. The advantages that I had while at a trading firm, allowed me to be successful using that trading style (in and out quickly).  Now, I use a much more conservative strategy that I will outline for all of you who want to begin trading on your own.  There are five steps.

Step one: Research, Research, and Research

NEVER purchase a stock when you have not done your homework.  Speculative investing is the fastest way to loose your money.

There is another serious problem I have seen everywhere—savings are put into risky investments that turn sour, and soon there is nothing left to pass on to one’s son.  The man who speculates is soon back to where he began—with nothing.  This, as I said, is a very serious problem, for all his hard work has been for nothing; he has been working for the wind.  It is all swept away.  All the rest of his life he is under a cloud—gloomy, discouraged, frustrated, and angry.  (Ecclesiastes 5:13-17)

I can’t tell you how many tips I have heard from self claimed “savvy” investors, “This stock is going to go sky high!  I made $3,000 from ABC yesterday!”  This could be true, and the stock could very well appreciate.  However, I will assure you that you will rarely hear stories of losses.  Only stories of profits made of smart decisions.  It is hard to believe that NO ONE is loosing money.   The bottom line is, don’t listen to or “believe the hype”.  Perform your own due diligences to a company before you purchase its stock.  “Steady plodding brings prosperity; hasty speculation brings poverty.” (Proverbs 21:5)  What does the company do? How well has it been performing? Does it make money? How fast is it using the money that it is making? Does it have interesting products in the product line? How much debt does it have? Is competition already too thick for this start-up to survive (if it is a start-up)?  Do your fundamental analysis of the stock.

Fundamental Analysis–Analysis of security values grounded in basic factors such as earnings, balance sheet variables, and management quality. Fundamental analysis attempts to determine the true value of a security, and, if the market price of the stock deviates from this value, to take advantage of the difference by acquiring or selling the stock. Fundamental analysis may involve investigating a firm’s financial statements, visiting its managers, or examining how a particular industry is affected by changes in the economy. (Dictionary.com)

You don’t need to sign up for a class at your local college, but you should be aware of the basic tools of fundamental analysis if you decide to invest in the market.  A simple 30 minute tour of yahoo.finance.com will do.

Step Two: When Should I Buy?

When I was trading this was a question that we asked every day.  Is this a good entry point, should I wait until it hits this level, or are there a lot of sellers around here?  These questions and many more were a critical part of the job.  We did our share of fundamental analysis, but we also relied tremendously on technical analysis.

Technical Analysis–The study of relationships among security market variables, such as price levels, trading volume, and price movements, so as to gain insights into the supply and demand for securities. Rather than concentrating on earnings, the economic outlook, and other business-related factors that influence a security’s value, technical analysis attempts to determine the market forces at work on a certain security or on the securities market as a whole. (Dictionary.com)

If we looked at a chart, and we liked what we saw, we would invest.  However, remember, we were active traders with great advantages over the typical at-home investor.  My best advice to those of you who want to invest is that if you do your homework, and if you like what you see, then buy the stock!  One of the best methods to purchase any stock is dollar-cost averaging.

Dollar-Cost Averaging– Investment of a fixed amount of money at regular intervals, usually each month. This process results in the purchase of extra shares during market downturns and fewer shares during market upturns. Dollar-cost averaging is based on the belief that the market or a particular stock will rise in price over the long term and that it is not worthwhile (or even possible) to identify intermediate highs and lows. (Dictionary.com)

If you have $5,000 that you want to invest in a stock, an example of dollar-cost averaging would be to invest $1,000 per month for 5 months.  The object here is to be able to buy more shares of a stock should it depreciate, and fewer shares if it appreciates.  Nobody has ever been able to consistently time the market; trying to time the dips perfectly can be a very discouraging task.  Dollar-cost averaging takes the human emotion out of the equation.  Trust me, if you have done sufficient research, and believe in the company’s long run potential, you will increase your odds of being a winner in the end (although nothing is guaranteed in this market).

Step Three: Don’t put all your eggs in one basket.

Once you have researched a stock, and decided that you want to begin your dollar-cost averaging, continue to research other securities that you can purchase.  No one person should ever have too much of any one investment in his/her portfolio.  Too much weight in options, real estate, stocks, bonds, can be very dangerous.  In relation to stocks, many portfolio managers use the 5% limit rule.  This means that no one stock is going to make up any more then a maximum of 5% of any one portfolio.  This is called diversification.

Diversification–The acquisition of a group of assets in which returns on the assets are not directly related over time. An investor seeking diversification for a securities portfolio would purchase securities of firms that are not similarly affected by the same variables. For example, an investor would not want to combine large investment positions in airlines, trucking, and automobile manufacturing because each industry is significantly affected by oil prices and interest rates. Proper investment diversification, requiring a sufficient number of different assets, is intended to reduce the risk inherent in particular securities. Diversification is just as important to companies as it is to investors.

If a stock’s value increases causing it to break significantly above 5% of the portfolio value, shares are sold to decrease the value until it is once again 5%. Conversely, if the stock depreciates significantly, and the manager still believes in the stock, he/she will purchase more shares to increase the amount of stock in the portfolio.  This allows him/her to keep a balance in the portfolio, while not allowing any one stock to gain too much exposure at one time.  I am sure that the employees of Enron, who had most of their investment in company stock, wished they listened to this advice.

Step Four: Stick to the plan!

Before you purchase a stock, you should already have a plan in place.  What is your timeline for this investment?  If the stock depreciates in value, at what price are you willing to say, “Enough is enough”?  How much of a gain are you willing to except before you take some off the table?  Whether you are an active trader, or a long term trader, you need a plan.  There have been many times when I have purchased stock at $10, and I say to myself, “I will sell it if it breaks 9.50 to the downside.”  I don’t just arbitrarily pick this point.  This point is chosen after doing my technical analysis, and being able to discern that this point signifies that the stock is “broken”.  (Broken=A term used by traders referring to the expected sharp decrease in value after a stock has breached a specific technical level.)  There have been times when I have “sold the bottom”. (Sold the bottom=A term used by traders to indicate that they have sold at the lowest possible point of the day, only to unhappily see the stock appreciate.)  However, more often than not if I stick to my strategy, I have made money.  Investing is not a game where you attempt to be right 100% of the time. You simply have to be right more often than you are wrong, and you will make money.  Discipline is a needed trait no matter what form of investing you do.  “He openeth also their ear to discipline, and commandeth that they return from iniquity.” (Job 36:10)

Whether it is dollar-cost averaging or active trading, stick to the plan.  If you are dollar-cost averaging and the stock depreciates a great deal, don’t panic and sell every share.  At this point, you should have done your research and know that you have invested in a quality, sound company.  This could be an excellent point to purchase shares at an economical price, reducing the average cost of your ownership.  Don’t loose sight of common sense, however.  As with Enron, if you hear news that drastically alters your perception of your investment as being investment-worthy, by all means sell the stock.  Take your lumps and get your tax write off against the loss.  As I stated, the investment game does have risks.  I wish it were so, but you can’t win them all.

Step Five: Don’t forget you have invested!

Many times, people invest in stocks and they forget about them once they have purchased them.  This is your portfolio, and it is your job to monitor them.  I know it is easy to allow your Financial Planner to run the show, but this is not a wise move.  Take ownership and responsibility for what is yours.  Read the news on your stocks and watch how they react to the different news and new elements presented within the marketplace. Learn about their competitors. Monitor fiscal policy and how it affects your stock, and keep an eye on anything that makes your stock move—whether it is micro or macro.  I don’t advise personal investors to participate in active trading, but I do advocate that they should actively monitor their portfolio.  Be careful and have enough discipline to be able to watch the value of your portfolio decrease before your eyes if the market turns south.  As you watch this, be confident enough that you have developed a well thought out plan that will protect you, lessen your risk, and increase your odds of benefit over the long run.  A good financial planner should be able to assist you with this.

If you have any financial questions, call me at 718-623-3423 or email me at ryanmack@optimum-capital.com.