A stock trading stratagem is a plan or approach that helps an investor to decide which stocks to purchase and what to sell. For a person who has just stepped into the stock market, it is not wise to adopt a strategy immediately, but keep his or her mind open to new ideas and views before selecting a plan. Even if a specific approach or plan appears to be sensible to the investor, he or she needs to do addition research on the matter. It is true that it will take some time before an investor is able to decide on a specific investment plan which will not only be prudent, but also enhance the worth of his or her investment portfolio. Besides, an investor must always bear in mind that he or she should never be confined to a single strategy. It is, however, true that while many investors and stock traders make use of an assortment of stratagem, there are many others who contended only with one plan. Irrespective of the strategy that an investor may prefer to use, he or she should always keep in mind a few important things that are mentioned below.
Hence, it is essential that an investor takes enough time before selecting a strategy or a cluster of strategies that suits his or her character and way of life. However, it is really regrettable that there is no magic to find what will ensure success in the stock market. Hence, only adopting a trial and error method will help one to find out what will work and what won't on the Wall Street. And this holds true for all at all times.
The rationale behind the buy-and-hold plan is that if an investor acquires a stock in a basically reliable corporation and holds (retains) it for a reasonable period of time, say, for a minimum of one year, he or she is most likely to earn profits from it. The advantage of adopting a buy-and-hold strategy is that in this case an investor can purchase a stock and observe its price go up without being bothered to follow the market trends all the time. In fact, investors who had bought stocks in corporations such as GE, IBM and Microsoft quite early and retained them earned plenty of money on paper without having to bother about the market conditions. The buy-and-hold strategy offers another significant benefit to the investors. When an investor adopts this plan, he or she is not engaged in buying or selling stocks frequently, and, therefore, are able to save substantial amounts by not having to pay any commission to the stock brokerages. Hence, it may be safely deduced that the buy-and-hold strategy is one of the best and most secure plans that an investor may make use of in the usually unstable stock market. Looking back, one will find that this strategy proved to be very effective all through the bull market in the 1990s.
Normally, buy-and-hold investors do not easily sell the stocks they own and if they actually do, it is perhaps only when there is some basic alteration in the corporation whose stock they possess. They never sell the stocks owing to changes in the market condition, the fiscal system or the price of the stock, but only if they think that there is something is gravely wrong in the corporation. In fact, these investors are basically concentrated on the company and they are determined to retain their realistically priced stocks for as much time as it is possible.
Billionaire Warrant Buffett is one of the most successful buy-and-hold investors of the 20th century. Buffett seldom acquires stocks in the technology companies, but prefer to buy stocks in the old fashioned and boring companies like insurance firms and banks. In addition, aided by a team of free analysts, Warren Buffett possesses the expertise to buy stocks at a low price and sell them at higher values.
While the buy-and-hold strategy works best when professionals use this, during the recent bear market, it was seen that numerous investors who adopted this plan virtually lost all their savings. The primary reason behind this fiasco was that these investors had bought and held technology stocks at very high prices. Although the buy-and-hold strategy works fine in stock trading, but it is not as easy to implement this plan as it may seem to be.
Another stock trading plan, the buy-on-the-dip strategy too was well accepted by the investors throughout the 1990s. According to this plan, when an investor finds the price of a stock dropping and is of the view that the fall is only provisional, he or she purchases more shares of the stock. In other words, 'buy-on-the-dip' refers to buying a share when its price is falling. The concept behind this approach is that the markets are never steady and when the price of a stock is falling now, it is likely to go up again sooner or later. This belief gains ground from incidents in the past. Hence, when the price of such stock goes up, the investor eventually sells it to make substantial gains. Normally, investors who had made use of this stock trading plan in the past had made loads and loads of money since the stocks they had bought when their prices were low, kept on going up and up.
However, like any plan or strategy, buy-on-the-dip too has some shortcomings. The basic problem with this plan is that some stocks usually decline twice or thrice before plummeting for good. In fact, during the later phase of the 1990s, millions of investors had put in their entire life's savings to purchase stocks that appeared to be good deals, but were actually awfully high-priced. Incidentally, whenever the price of a stock dropped further, more and more investors flocked to buy them. Unfortunately, after that, many of these stocks did not just fall for a short term, but crashed during the bear market in 2000. It must be mentioned here that all through the recent bear market, the stocks listed on the NASDAQ declined by more than 80 per cent! Now it is really too soon as well as difficult to make out whether the pre-crash price levels of these stocks will ever be restored.
In the stock market parlance, a bottom fisher is a bargain hunter who is searching for firms or stocks that appear to have hit the rock bottom or fallen temporarily. In fact, proficient bottom fishers are constantly on the look out for socks that have dropped so low that they have no movement option other than going up again.
However, the bottom fishing strategy is not bereft of its shortcomings. The peril of adopting this plan for stock trading is that on many occasions, the investors are not aware when a particular stock has precisely hit the bottom. For instance, when the price of the electric giant Enron shares nosedived from $100 per share to a mere $15 a share, majority of the investors were of the view that the stock had hit the bottom and could not fall further. But the value of the stock did fall further and when it was trading at a lowly price of $1 per share, the bottom fishers intervened. In fact, the Enron stock dropped approximately 94 per cent prior to actually reaching the bottom and eventually closed at a mere 6 cents! Any investor adopting the bottom fishing strategy often also confronts hazards like the Enron, which finally went bankrupt before closing shop.
It is essential for an investor to possess loads of patient in order to become a successful bottom fisher. Patience is the key words in bottom fishing as it could take many years before the loathed stocks bought by these investors again witness a rise in prices. Speaking in the stock market terminology, stocks that have reached the basement are usually inclined to remain there for quite some time. In fact, there are several bottom fishers who will usually hang around for two to three years before they pick up their preferred stocks, which other investors have discarded.
Another viable strategy in stock trading is to purchase stocks on a regular basis and in a methodical way. There are many investors who will buy stocks erratically and only when they have some surplus money with them. However, with the dollar-cost averaging, an investor should have a more organized approach to stock purchasing. For instance, an individual may adopt a systematic approach to buy stocks if he or she decides to purchase stocks for a fixed amount of money for each fixed time period -- like buying stocks worth $100 dollars every month. The benefit of such a systematic method is that since the investor will be purchasing stocks whose prices are going down, the mean cost for every share he or she buys also goes down.
Let's take the example of the Bright Light shares to understand the issue better. For instance, let us assume that an investor acquires 100 shares of Bright Light at $20 per share. On the following month, the price of Bright Light shares drop to $10 per share enabling the investor to buy 200 more shares with the fixed money. Now the mean price of each Bright Light share will be $13.33 - 300 shares for $4000. And given that the market continues to get better, the dollar-cost averaging is an appealing as well as successful plan in stock trading. However, the downside of this strategy is that if the stocks purchased by the investor continue to go down, it may him or her suffer considerable losses.
There is another strategy that is much akin to the dollar-cost averaging known as averaging down. According to the averaging down plan, as a substitute to purchasing stocks with a fixed amount every fixed period of time, an investor buys extra shares of a stock whose price is going down. When an investor is following the dollar-cost averaging, he or she is working according to a systematic plan. But when they adopt the averaging down method, they simply buy extra shares of a stock whenever they want to.
Value investing may be described as an investment method that advocates good stocks at great prices over great stocks at good prices. In other words, value investing basically makes use of elementary analysis to select first-rate stocks that are considered to be a good deal in comparison to their real value. In effect, the value investors are always on the look out for stocks that are on sale or available at discounted prices. Usually, the value investors will acquire stocks in corporations that most investors are not interested in. Such stocks have a poor P/E or price/ earnings ratio and are issued by corporations whose revenue increases little by little, for example insurance firms and banks. Like the buy-and-hold investors, the value investors too are long-term shareholders who are generally prepared to linger for years before the stocks they own eventually turn out to be money-making.
It is interesting to note that the value investors were actually faced a lot of scorn all through the 1990s for not buying the extravagant technology stocks. This is primarily owing to the fact that compared to some growth stocks that were virtually doubling or even tripling in price, the income generated by the value stocks were considered to be deplorable. Paradoxically, when the bull market of the 1990s came to a close, the value stocks were once again a favorite of the investors. Following the 1990s, almost every seasoned investor yearned for buying even somewhat valued stocks in corporations managed by proficient and sincere professionals, as the value stocks now demonstrated signals of enhanced performance vis-à-vis profitability.
In the stock market parlance, buying growing companies denotes purchasing stocks in corporations whose earnings are more in comparison to the economy. Generally, the growth investors or shareholders make use of basic research to get stocks that are yielding more profits compared to the earnings from other stocks in the same sector. The growth investors normally are fond of watching the earnings from the stocks owned by them by a minimum of 15 to 20 per cent during the subsequent three or four years. It is important to mention that the incomes of the growing companies increase more rapidly in comparison to the profitability of other companies in competing industries. In general, the growing companies do not make any dividend payment to their shareholders and the entire surplus amount earned by them is re-invested in the expansion of the company.
Investing in growing companies has performed exceptionally well for several years. All through the bull market of the 1990s, putting one's money in the growth stocks, especially the high-flying technology and Internet firms was frenzy among the investors. Although it may seem to be incredible, it was not unusual for many growth investors to find that their returns from investing in such companies totaled to 100 per cent or even more annually. While it is a fact that putting one's money in the growth stocks can often be hazardous, it is also true that the earnings from these stocks can also be incredible.
The growth at a reasonable price (GARP) may be called a derivative of growth investing. Investors adopting this approach mainly merge value as well as growth into one plan. Although these investors are on the lookout for acquiring growth stocks, they are also prepared to hang around till they can find the stocks at a rational price.
Growth investors who are always searching for stocks that are geared up fiery upward movements are also known as momentum investors. These momentum investors normally purchase stocks at quite high prices with the intention of selling them at even higher prices. Till the prices of the stocks continue to rise, these investors are not bothered about the price they need to pay to buy them. In fact, the momentum investing strategy yields best results during a bullish market when there is plenty of liquidity or the ability of stocks to be converted into cash quickly. It may be mentioned here that during the late phase of the 1990s, irrespective of the stock bought by an investor, it was almost sure to move upward. This was especially true for the extravagant Internet stocks.
Incidentally, momentum investing has been often described as the 'greater fool theory' by a number of critics. In other words, this denotes that irrespective of the high price an investor paid to buy a particular stock, he or she will always find another bigger dupe who is prepared to buy it for an even higher price from them. In fact, momentum investors are inclined to make use of procedural analysis while looking for stocks that they think would make rapid and spectacular upward movements in a brief while from their purchase.
It is interesting to note that even a surprise declaration or positive gossip was able to push up the prices of stocks by 20 to 30 points in a single day during the aggressive or bullish 1990s. It is possible that one may come across momentum stocks even now, but it would not be an easy task like before to find one.
Although it is very thrilling and has the prospective of yielding quite high returns, basically, momentum investing remains a very difficult plan. People buy momentum stocks expecting them to move upwards impulsively, but the fact is that they are capable of moving in any direction. And in case, the momentum stocks start exploding downwards, it may result in the investors losing a considerable amount of money. However, it feasible to find some of these stocks moving swiftly upward, it is not as easy a task as it may seem to be.
A contrarian investor is a shareholder who acts contrary to the prevailing acumen. For instance, a contrarian investor will normally buy stocks when other investors are cynical about the market conditions and selling the stocks they own. Even when the contrarian investors are optimistic regarding the market situation, they will normally purchase shares that have been loathed by others. Again, in a prolonged bull market, a contrarian investor will usually be bearish in mood or will prefer value stocks to growth stocks.
In general, the contrarian investors make use of basic research to look for premium corporations having low down P/Es or price/ earnings ratios that other investors have discarded. It is strange that the more the other investors dislike a stock, the more it is liked by the contrarians, as they prefer themselves to be known. For instance, while most investors were engaged in hectic buying of technical stocks all through the bullish market in the 1990s, the contrarians were busy acquiring stocks in loathed corporations such as the Waste Management (WMI) and Ret Hat (RHAT). When several technology stocks caved in, the contrarians were busy picking up shares of detested corporations such as Xerox (XRX).
It is interesting to note that the contrarian investors are particularly mesmerized by any corporation that is on the hate list of the media as well as other investors. All said and done, it definitely requires incredible talent and expertise to locate stocks that were high-flying in the past and has the potential to beat the market once more. What is more important is the fact that it requires loads of nerve and confidence to purchase stocks that others loathe.
A section of contrarian investors are also known as 'investolators'. These stock traders make use of technical research, particularly charts and institutional possession, to get stocks that they want to buy.
There is also a group of contrarian traders called "investolators" who use technical analysis, especially charts and institutional owner-ship, to find stock picks. Just like contrarian investors, investolators look for unloved companies that have hit bottom. Ted Warren coined the term investolator in the 1930s, combining the words investor and speculator.