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We’re going to talk about how you make money in the stock market and survive its rough seas in this post.
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You’ve heard about the stock market, right? It’s one of those places where people become instant millionaires without breaking a sweat? …overnight? …while wearing pajamas? …in their spare time? …and enjoying the cool breeze in some resort somewhere in Bali? …being served with fine wine and mouth-watering food?
Ah… I love that picture. And it’s also untrue.
Well actually, it is partially true. But only as to the wearing pajamas part. Mostly. However, if you do this right… if you let this guide guide you… (pun intended) then you just might get to the working in a resort in Bali part. Just don’t expect someplace really fancy at first. (And skip the expensive wine)
Please note, though, that I’m not one of those boring and naggy financial advisors you may have met. And I also don’t play one on TV. So please, don’t take this post as some sort of financial advice. Sound financial advice could only be given by someone who knows the particular circumstances of a person or client, among other things. I can’t do that here with you, so I am just going to share with you the things that people found to have a good chance of taking home some gains from the stock market.
With that out of the way, let’s get on to business. The sounds of the alluring waves of Bali await us.
The things you need to do are:
1. Focus on your areas of expertise,
2. Analyze the markets,
3. Plan your trade, and
4. Stick to the plan no matter what.
Focus on Your Area(s) of Expertise
Focusing on your area of expertise is important for you to effectively analyze the market in the next step. There is just plenty of things to consider. So many news, reports, and materials to go over and digest. The best way to keep on top of things and absorb all the materials that you need to investigate is to have significant knowledge of the industry you are investigating.
You don’t have to worry, though. PhDs are not required. When I said expertise I did not mean something academic. You just have to know the area well enough. For instance, you don’t need to have a degree in Agricultural Engineering to invest in stocks that belong to the agricultural and closely related sectors or industries. It’s enough if you are from a family that has been operating a farm that’s been with the family since your great-grandparents or even before them. You’d clearly know more about the intricacies of the business than any Wall Street operator could.
Did you just say you like love beer? You’ve researched the many ways of brewing the thing. Ireland is your favorite vacation spot, eh mate? I bet you could better assess consumer reaction to or acceptance of some business decisions a company related to that industry would make. You would then be way ahead of the other stock market players.
Never do shotgun investing. Pick an area you know quite well–something you have experience with or are passionate about. It could also be something related to your current job. A degree in Agricultural Engineering, if you have it, wouldn’t hurt, either.
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Analyze the Markets
Analyzing the market is infinitely easier, more fun, and more efficient if you limit yourself to a small and interesting part in the manner described above. The limited scope makes the analysis easier to deal with and therefore less stressful. We can also do a deeper and more effective analysis than if we spread ourselves too thin on a wider market or set of securities. This also gives us more chances to kick some Wall Street behinds.
There are two main ways to analyze stocks (and the market as a whole):
1. Fundamental analysis, and
2. Technical analysis.
I’ll give a more thorough treatment of each of these two in another article. (If the planets align in just the right way) They deserve more than the few lines we could allot here. There are, in fact, a whole bunch of books about just fundamental analysis and another just for technical analysis. Countless shelves had sagged by the amount and weight of those books. The topics are just too deep for us to treat well here.
The Nature of Technical and Fundamental Analysis
For our purpose here, though, think of fundamental analysis as studying the underlying fundamentals of a stock or market–the inherent qualities that make them attractive or unattractive to investors. For instance, we look at intrinsic value when we do fundamental analysis. After determining this value, we check whether the security is undervalued or overvalued.
In technical analysis, we are more concerned about how prices of those stocks and markets move, the patterns they make, and where they may end up next. Technical analysts are not very concerned about what the value of security might be. As long as people are interested in buying it and the prices are rising, they are bullish. In the same manner, they either stay away or short falling stocks even if the company is intrinsically valuable.
Many investors prefer one or the other. Some use both but at varying weights (i.e., more technicals with a tad of fundamentals). In subsequent posts, I’ll delve deeper into the topic so that you can make a more intelligent choice.
Technical and Fundamental Analysis Applications
Technical analysis is great since you can apply what you learned in many different markets and instruments. Fundamental analysis is very domain-specific–fundamental analysis for stocks is different from that of commodities and currencies, for instance. However, that should not matter much because we are supposed to limit ourselves to a narrow segment, right?
Fundamental analysis can give you more in-depth intelligence than technical analysis, though. It allows you to inspect companies at a deeper level. For that reason, you can invest more intelligently and with more confidence. It doesn’t matter if it is domain-specific. After all, we are already focusing on an area we are familiar with.
Make a Plan
After doing your analysis, it’s time to chart your course and make a move. The analysis in the preceding section should tell you which stocks should be bought (or sold). At this stage, you need to set price points for entry and profit-taking. You also need to figure out what to do if the trade goes against you. After all, you wouldn’t be right all the time, would you? So when the inevitable mistake happens, would you buy more to average down, or cut your losses fast? That is something you definitely should plan for
Entry
Suppose your analysis tells you that the stock is going up. This means you’d want to buy it so that you can later sell it at a higher price. However, at what price should you buy? Would it be good to enter at the current price, or should you wait a bit more for a dip? If you wait, won’t you be left behind as the stock continues to soar and break higher highs?
These are the questions you need to consider and honestly, it’s not that easy to answer those questions. How you deal with it would depend mostly on whether you rely on technical analysis or fundamental analysis. They each have their own approach to the issue. But even just among technical analysts, there still are many different ways to deal with this depending on what technical strategy you choose to implement. The same holds true for fundamental analysts.
We will give this topic a more thorough treatment in other articles. For now, just know that those are some of the things that need to be considered when determining entry points. And remember: this is still just for the entry. We haven’t even talked about the exit yet.
Exit
Some would say that the right exit is even more important than the right entry. It is quite possible to enter at the right point and still lose money. Let’s say you think the stock of Facebook is about to soar and you correctly entered at a particular price. You happened to be right and the stock is now trading higher than your entry. You are elated.
However, you set your exit price a bit too high–higher than it should be. And before your target was hit, the stock plunged back down due to some news about a hack or a security breach. Or maybe a new regulation was adopted that happened to be unfavorable to the company. Because of this unexpected news, your stock is now down below your original purchase price. This means you are now losing money. You almost had it, but you were not able to exit before the crash happened and, therefore, were not able to lock in your profits.
Just like when thinking about your entry, there are many ways to approach this. And the strategy you choose should not conflict with your entry strategy. There are many good ways to exit the market, but only some might make sense based on the entry technique you prefer. Obviously, it should also be consistent with your overall strategy.
What if You’re Wrong
You can never be right all the time. I wish it were otherwise, but that would never happen. Unless of course, you’ve been dreaming by now in that pool somewhere in Bali. In fact, it would already be super awesome to be right even just 50% of the time. That would be enough. But being wrong is fine. There is no need to make a big deal out of it. The important thing is that you should make being wrong part of the plan. If you do, you’d survive. …maybe even thrive.
There are two main ways to deal with mistakes:
1. Cut your losses quickly and buy back at a lower price, or
2. Average down your losses.
The first option is to sell your holdings the moment your trade goes against you by a certain amount or percentage then re-enter at a lower price. The nice thing about this is that you have cut your losses short. You can’t lose more than that amount even if the stock really goes way down.
The disadvantage of this is that you incur more costs. You have to pay commissions to your broker for the sell transaction and another for the re-entry transaction. The other thing is psychological. It is a definite admission that you were wrong. And some people find it hard to accept that. This messes up their mind and negatively affects subsequent trades.
In averaging down, you don’t exit the trade. You simply buy more every time the stock price falls. This lowers your average cost as you keep on buying at ever-lower prices. Since there is no exit and re-entry, there are no additional transaction costs that you have to pay to your broker. But it is quite scary, though. What if the stock keeps on falling with no signs of easing up? Hard to sleep with that one.
Not only should you have nerves of steel when going this route, but you also need to have deep pockets. Remember, you keep buying more every time it goes down. How long can you keep doing that? This option is not ideal for those with limited capital.
Most technical analysts choose the first option, while most fundamental analysts choose the second. Most, but definitely not all in each case. The choice would also depend on whether the stock is intended to be held short-term or long-term. Your entry can also be a determining factor when choosing between the two options. Some entries just require a cut loss once the trade goes south.
Stick to the Plan
Once you’ve made a plan, you need to stick with it. Obviously, right? You’ve spent a lot of time designing your plan, tweaking your entry and your exit, figuring out a plan B when things head south, and all those things. It’s a waste if you are just going to abandon that plan when something else comes up.
But aside from that, there are also other reasons why you should stick to your plan. One of them is emotion. Emotion is a very dangerous thing for a trader. Fear can scare you out of a trade just when it is about to recover; greed can seduce you to enter a soaring stock about to be dumped. (with you in it)
The problem is that it is so hard to deal with emotions. That’s why you needed a plan in the first place–a plan you formulated when you were cool and level-headed. By sticking to the plan, you will (hopefully) not be swayed by whatever emotion happens to get a hold of you. So, stick to the plan!
And Finally, Have Fun
What’s the point in all this if you’re not having fun? Might as well get a regular nine-to-five job if that’s the case. Work hard, play hard, they say. Thankfully, it’s not hard to have fun while trading in the stock market. (You did choose to focus on industries that are interesting to you, didn’t you?) Unlike many jobs, you are not trapped in an office in a nine-to-five routine with annoying coworkers thrown in as a bonus. There’s no need to commute, even. And don’t get me started with those pesky office politics. Nobody likes those. This gives you tremendous freedom to choose how you want to work–and where (clue: the pool in Bali).
Feeling adventurous, fine. Head out to the mountains, or hop on a plane to some exotic location halfway around the globe. All you need is your laptop computer, a power outlet, and an Internet connection–swimwear optional. If you are feeling lazy at the moment, you can just stay on your bed with a huge bag of potato chips, a dip, and soothing music playing in the background. Your choice. That’s the beauty of working in the markets.
There is also an added benefit to having fun than just being fun. It stimulates your creative mind. And a creative mind allows you to see trends and patterns that you might otherwise have missed. Also, a relaxed mind is a productive mind. You can do more analysis and craft better, more effective plans when you are calm and composed.
So, what about that resort in Bali? Sounds like a really great idea, isn’t it? But before you start packing and clicking your way to an online booking website, bookmark this site, subscribe, pin it on Pinterest, and do all that other wonderful stuff to make sure that you get updated when we post something new.
Okay, now off you go. For now. We surely have more to talk about how you make money in the stock market and other topics about the stock market. This is just scratching the surface and whetting your appetite. And don’t forget to check our recommended books.
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