So now you actually have some cash to invest. But what do you invest in and what kind of strategies do you need to gain the most bang for, quite literally, your buck?
Don’t be too hasty in placing your cash in the first attractive investment that you chance upon, but at the same time don’t be scared off by the options available. There are several approaches that you can take to decide what to purchase and how to manage your investment portfolio. The major categories of investment style that you need to know about are value investing and technical analysis.
What is Value Investing?
Value investing is a popular choice amongst investors. This approach involves looking at the fundamental characteristics of the equity. Essentially, this means you have to look at the factors that impact how successful the particular company has been and has the potential to be. When you are considering value investing, you look at the same kind of signals and information as you would when you think about companies and businesses and their ability to make profits.
When applying value investing, you will select your portfolio purchases based on a range of factors that affect profitability. Start by taking a look at the company’s financial. Financial statements are accounts that the company produces for shareholders and potential investors periodically – or at least annually. The key statements to look at are balance sheets, cash flow statements and income statements.
You can gauge the growth trend and ability of the business by looking at their history. Plus, take a look at the wider range of economic factors that the business is exposed to – such as national economic upturn, or a downturn in a particular industry, media scandals etc. Basically, look at all of the factors that centre on the profitability of the company. Profits drive the returns on your investment through higher share prices and dividends.
These factors combined help you and other investors to establish the fair price of a share in the company. If the price in the stock market is below this fair price then you have found a good investment – we say it is undervalued. This is where the term ‘value investing’ comes from. This type of investing means you will need to make a consideration not just of the past success of the business but on the ability of the company to generate successful returns in the future also.
By looking at the factors mentioned you will be able to forecast, to a certain extent, how the business may perform going forward. This type of investing style is longer term. It is about making a well-researched judgement call on the long-term potential of your invested money.
What is Technical Analysis?
Technical analysis, as the name suggests, is a more technical style of decision making. Unlike value investing, this style of investment is more short term – looking at time frames of months, weeks, days or even minutes in which to buy and sell.
It is about identifying short term opportunities in which you can sell your investment at a higher price than which you bought it. The decision making for buying and selling is made purely on looking at charts and patterns of stock prices. This approach is not about looking at any economic or business concepts – it is an approach based on statistics and graphs. Do not let this intimidate you – in some cases the charts and maths involved can be very straightforward.
A further key difference of technical analysis compared to value investing is that it only looks backward in time – no consideration is made of future market conditions. By looking at past patterns of stock price behaviour, the analysis allows you to predict what will occur next and what asset to buy or sell. This is based on the expectation that what happened previously will continue in the pattern you have identified in your analysis.
Past market activity is used to predict activity in the future, assuming the trend will continue. This type of approach is often referred to as trading, rather than investing due to the shorter time frame and narrower perspective involved.
By looking only at the charts, you’re assuming that all other market factors will already be considered into the market stock price and there is no need to evaluate them extensively beyond looking at market behaviour. When applying technical analysis, the first place to start is to look at the price and volume patterns of the stock you are considering investing in. The next step is to look for patterns in this data. For example, you could be able to find a trend in the correlation between the stock price and the time of year.
Other examples include the relative strength index, moving averages, regressions, inter-market and intra-market price correlations – which are not as scary as they sound! Chart patterns are used the most and this refers to the chart of the price of the asset over time. For example, spotting a trend in the price point where a stock price might turn upward is calling finding a support level in the price pattern.
Continuing this example, you may notice that when the share price of Company X has been moving up and down over the past 3 years that whenever it falls to $40 it starts to pick up again. We would say that $40 is a level of support in the chart for Company X and you could make a rule to buy that stock whenever it reaches $40 and sell it when it moves up. The patterns you identify help you to set rules of when to buy and sell. That set of rules is the core of the investment strategy.
Whichever investment style you go for make sure you understand the risks – longer term investment, based on extensive research is a more reliable and stable source of gains on your money and this would come from value investing. However there are larger short-term opportunities out there which can be captured through technical analysis – but this strategy is often more risky and volatile and can also lead to larger losses.
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