Friday, January 19, 2007

Psychology of Trading

Quite aptly said:

"If you don’t follow the stock market,you are missing some amazing drama."
~ Mark Cuban

A lot of my friends have been asking me about investing and planning to venture into the stock market. Finally, I decided (from some inspiration from another investor friend in India) to create and start writing on this blog about my beliefs, thoughts, revulsions, speculations and judicious views since my foray into investing. This blog is for all those people who desire to invest in the stock markets but do not know where to start from and for the ones who keep wondering " I have heard of Warren Buffett". Read on and probably you shall get to know him better :)

My sincere attempt in explaining and sharing the realms and fancies associated with investing. Buying stock in a company is relatively easy once you've researched the stocks you're interested in and have a broker or brokerage account to handle your purchase. I shall try to write more about the aspects relevant to investing, surviving and the strategies in this article. However, shall definitely create another post explaining the easy part of carrying out the transaction.

The Plunge
Probably, I should start with some advice from the Australian investor.
"When buying shares, ask yourself, would you buy the whole company?"
~ Rene Rivkin

I guess this is one of the most introspective guidance one should diligently follow when investing in stocks. I guess the first question which comes up is which stocks to buy ? Don't buy the stocks only because you like the products of the companies or because some friend told you inside news about their latest offering.

To start off, my personal and sincere advice: Read websites about market talk and the advice they have to offer, tune into CNBC (Mad about Money) and start grabbing info. through magazines like Business Week and others. Once you get into the mode of understanding the stock picking rants would you finally find yourself comfortable and inquisitive to research further more before you dive in. Also, companies make up the index and the index does not drive the company stocks so think about investing into individual companies than putting in all your money into the index. Have a balanced and diverse portfolio so that if one sector goes down it does not take you with it. You should look for companies with specific dogma and stories associated to it and not for the ones who are making money because the economy is getting better.

Long term investing

"Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years."
~ Warren Buffett

Had you put $10,000 into Berkshire Hathaway when Buffett bought control of it in 1965, you'd have more than $50 million today, compared to the just under $500,000 you'd have if you'd invested in the Standard & Poor's 500 stock index. Again, remember companies make the index and not the vice versa.

You should not be concerned with the supply and demand intricacies of the stock market. (atleast I do not understand the complexity in the financial world) You don't have to monitor your stocks and portfolio everyday every minute. According to Warren Buffett: "In the short term the market is a popularity contest; in the long term it is a weighing machine."

Studying the Sage (Warren Buffett, an excerpt from an investing article about him by Investopedia

'He chooses stocks solely on the basis of their overall potential as a company - he looks at each as a whole. Holding these stocks as a long-term play, he seeks not capital gain but ownership in quality companies extremely capable of generating earnings. When Buffett invests in a company, he isn't concerned with whether the market will eventually recognize its worth; he is concerned with how well that company can make money as a business.'

Though that does not mean you simply put your money in some stock and completely forget about it for 10 years.

Lose some
"You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets."
~ Peter Lynch

Don't let optimism overwhelm you here. Sometimes the economy does go through a slump and believe me even we have to bear the brunt. Hence, you should (always) generally keep a stop loss. I generally keep a stop loss of 10%. For example, if I buy stock at the price of 100$ and if it continues to drop I sell it at 90$. Also, you should be able to sense the signs of mounting trouble associated with the particular stock. Watch out for the prognosticators,benefit and pull out accordingly. Safest way to invest would be to focus on companies that serve the middle class especially in maturing economies like India and China. You should pull the trigger if you see the following:

1. Poor fundamentals (earnings, revenues and cash flow)
2. Wall Street hype (look for the trends)
3. Falling return on capital ( gauge on how a company is using the shareholder's money)
4. Bearish bond analysts (follow their cues closely; when they raise concerns, heed them)

"When somebody buys a stock it's because they think it's going to go up and the person who sold it to them thinks it's going to go down. Somebody's wrong."
~ George Ross

History is not destined to repeat itself every time. (although it definitely repeats itself when price movement trends for equity are concerned) Hence, it is very important to have a goal and investment strategy for putting in your hard earned money. Perhaps, one of the most important thing is to be well informed about things happening around you. Look out for the oil prices, global trade, the merger mania, revenue growth of a company, housing recession, growth in jobs and incomes/wages, the annual budgets, monsoon, economic and strategic pacts, booming industry scenario, Fed cuts, inflation rates, labor markets, foreign exchange reserves, India & China, quarterly results, IPO's, global warming, emerging markets, forecasters, global outlook ,etc. And, believe you me, if you play your cards well there is always a lot of room for profit growth.


And finally some thoughts from the most prudent investor,

“In the business world, the rear view mirror is always clearer than the windshield.”
~ Warren Buffett

This is one of my personal favs too.

Always learn from your mistakes and continue to rectify and work on them. It is proven that you become wiser after the event however when it involves your own money you need to get it right the first time around. If you are more focussed into putting your money in international companies look out for the global economic growth and the GDP for the country as well. Try and take some time to understand the fundamentals of the company besides the regular technical analysis. Our goal is to maximize our profits and minimize (or eliminate) our losses. We should be careful and smart while putting in our money. Think big, curb your enthusiasm for recovery and backup your investment decisions with some scrutiny of the company's financial performance. Here, is a list of things what the greatest stock market investor analyzes and looks for:

1. Has the company consistently performed well?
2. Has the company avoided excess debt?
3. Are profit margins high? Are they increasing?
4. How long has the company been public?
5. Do the company's products rely on a commodity?
6. Is the stock selling at a 25% discount to its real value?

Hopefully, by now you should have the cognizance of how the markets work besides apprehending the art of investing.

I hope you start and continue to and finally go on to make a fortune with some astute investments. Feel free to mail me for any further questions, suggestions and comments.

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