If you’re an individual investor in the stock market, the first thing you should know is that the deck is stacked against you. Your investment in a company’s shares will not move the price, so the only way you “win” is by being lucky enough to buy before institutional investors or hedge funds pour hundreds of millions, if not billions, of dollars into the shares you already own. As they say, “a rising tide lifts all boats.”
In many ways, if you keep this basic premise in mind, you will understand the following fundamentals of becoming a successful investor. Here are three stock market investing tips for beginners!
1. Understand the Basics
Investing in the stock market doesn’t need to be complicated. While some investors devise complex algorithms, formulas, and screeners to compare return on equity (ROE), earnings per share (EPS), compound annual growth rates (CAGR) and P/E ratios, individual investors likely don’t have the same resources. But by sticking to fundamental investment principles, you can still earn a market average or higher return in your investment accounts.
- What kind of investor are you? If you are young, maybe you can afford the volatility of risky investments because you won’t be retiring any time soon; but if you’re older, the focus should be on wealth preservation and risk management. This outlook will determine what kind of securities you will want to invest in – equities or fixed income. Young adults will have a highly skewed ratio in favor of equities while those close to retirement will likely have a 50/50 or 60/40 split.
- Is the company under or over-valued? This is the most basic premise of investing. If you think the company is undervalued, then you buy the shares; if it’s overvalued, you either sell short (not recommended for new investors) or wait for it to reach a discount and then buy.
- Momentum is a factor. You may have read that stocks have headwinds or tailwinds and momentum in the stock price can be a factor. Headwinds indicate there are obstacles or challenges for the company/industry; whereas tailwinds are positive catalysts for future growth. When the stock market identifies tailwinds, a stock begins to consistently increase in price and build momentum. Because there is a lot of “positivity” towards the company or industry and its prospects, prices tend to overshoot with the expectation of strong growth. The same goes for the opposite – negative news can significantly discount share prices. The only issue is that your timing can be off – buy too early and the stock can continue to drop; buy too late and an overprice stock can start to correct downwards.
- Keep trading costs low. First, you shouldn’t be trading on a platform that charges excessive fees or costs. Start with a comparison website to find the best online broker reviews. Then decide on the types of securities you will be trading – some platforms are ideal for equities, others for options or mutual funds. Finally, brokerage firms will differentiate themselves on other auxiliary services such as free access to research, customer service, and wealth management advice.
2. Control Your Emotions
While analyzing, understanding and investing in the stock market does have an emotional or behavioral component, you need to be able to control your emotions. Your love and appreciation for a company’s products or services does not make that stock a good investment. This is because the stock market is supposed to be “forward-looking”, and it is very possible that your expectations for a company’s future success may already be priced into their shares.
However, you can use behavioral investing to your advantage. Because market sentiment such as fear or exuberance can cause prices to over or undershoot the intrinsic value of a company, being able to identify these moments can provide an investor the opportunity to buy or short sell shares.
Diversify Your Investments Up To A Point
After “buy low, sell high”, “diversify your investments” is arguably the second most popular adage trumpeted by experts. While diversity can protect you from large negative swings in the market, it can also dilute gains and increase trading costs. Research has shown that, after a portfolio owns 15 or 20 stocks, it should broadly represent the same risk as the market; beyond that number, both returns and reward vs. variability decay.
In the case of many amateur investors, it is cheaper and more efficient to use a robo-advisor instead of becoming a stock-picker. Robo-advisors use technology to automate the process of wealth management services. By asking basic questions such as age, income, risk adversity, and long-term investment goals, robo-advisors recommend a basket of low-cost index funds. Because human interaction is minimized, fees and biases are mitigated. Some of the best robo-advisors in the market these days include Betterment and WealthFront.
While there are dozens of investment principles, strategies and tips to keep in mind when saving and investing for retirement, these are a few ideas to get beginners started. Just remember to take things slow and not dive in – this is real money and losses can pile up very quickly.
What additional tips have made you a successful stock market investor?
Author Bio: Gary Dek and John Schmoll, two former finance professionals, are the founders of BestDiscountBrokerages.com, a review website committed to researching and rating the best discount brokers online.