Making money in the stock market can be a great way to supplement or replace your current income, but if you go about it haphazardly and without a good plan, it can also be a one-way ticket to the poor house.
Any kind of investment involves a certain level of risk. It is how you assess and manage that risk that determines whether you are an investor, a trader, or a gambler. When you are dealing with the stock market, being a gambler is the worst possible option. Let’s discuss a gambler first so you can see what you may be doing wrong and move to a more profitable position.
Rolling the Dice
A professional gambler will tell you that they have learned to minimize their risk. While this may be true, the information they can apply is still limited when compared to something like trading or investing (unless they cheat!).
When you put money into a trade or buy a stock for investment without researching the history or situation of the company, looking at trends in the price or the index, or being aware of news concerning the industry they are in, you are gambling. It’s like just rolling the dice and just seeing what comes up. The chances of getting the roll you want are far less than the chances of one of the many other, losing options.
This is basically throwing your money out the car window on the highway. It might seem fun at the time, and a few bills may blow back in through the rear window, but for the most part you are burning cash and watching the smoke rise. I highly recommend not doing this. While that may seem like the most obvious advice you have ever received, I can almost guarantee that at least a few of you have done this in the market. Being honest about your mistakes is the first step to correcting them.
Investing Well Requires Lots of Research
Warren Buffet is arguably the greatest investor in history. Do you think that he throws darts at a board to determine where he will put his money? I can tell you that he doesn’t. A successful investor knows where their money is going. They know the company they are investing in like it is a good friend. While you can’t always predict what your friend will do in any given situation, you usually have a pretty good idea how they will react in most.
In order to have a working knowledge of how a stock will act on a regular basis, you have to get to know it. Spend time reading about the company. Who started it? Who runs it now? Who are the key decision makers for it and what is their track record? These and other questions are vital to knowing how the company is run and what their future may hold.
The sector they operate in is just as important. If company X is the greatest widget maker in the world and the next best company is far, far behind them, they may be a great investment. But what if the trend in the world of widgets is that they will be replaced in the near future by wodgets? You certainly don’t want to put your money into a sinking ship, even if it hasn’t quite started sinking yet. Kodak has been a solid investment for many, many years. But with digital cameras eliminating the need for film, now where do they stand? I’m not saying that Kodak is not a good investment, I’m asking where they stand at this point in the industry. Have they adapted well enough to survive? Will they thrive or die? What are they doing now and what are their future plans?
These types of considerations are vital for putting money into a long-term play, which is what investing is. You also need to remain aware of changing circumstances, so that you can get out if you need to.
Investing is not only about stock price, though. A seasoned investor is looking more for stability than movement in a stock’s price. Dividends are an important factor as well.
The best way to make money on an investment is the Buffet method. When you have built up a strong holding in a company that is stable and growing, even at a small or even pace, you can sell calls on the stock that are out of the money enough to get a small but consistent return, with little risk of having to actually sell the contracts. Even if the stock price rises dramatically without warning and you do get called on the contracts, you win. You actually make more money when this happens!
Bottom line: spend time with your stock before you buy it, like you would court someone and date them before marrying them. It will give you the best return on your investment.
Trading is for Short Term Gains
Trading is a different animal than investing, and it requires different methods and research. While investing is best for years-long periods, trading is plays over one day to several months. Volatility is highly desired when trading, while investing requires stability and slow growth.
The tools used in trading are the same you use in investing, but they are analyzed on a much shorter-term basis. For instance, trend lines on a stock chart are important in both, but when investing you should look at monthly trends over a few or more years, while in trading you could be looking at as little as 5 minute periods.
There are trading cycles throughout the year that must be followed to be successful. In the summer, the market is generally very choppy and gains need to be quick and are often intra-day, while in the fall through winter trades can last for weeks. Knowing these cycles gives you good insight for how you should set your trades up.
Tools that can help you understand the way the market flows throughout the year are the Stock Trader’s Almanac, the calender for earnings, and historical charts that you can examine for trends in companies or indexes. If company Z has a drop in price after every spring earnings report, or a run-up in price leading up to it, this can be a regular play that you plan on. While current conditions always have to be taken into consideration, the trends make for a much better chance of the play going your way.
Trading is an excellent way to provide regular income week to week, while investing is more for securing your future. You can make money monthly or quarterly in investing using the Buffet method, however. A good plan is to trade for short term gains and then invest part of your earnings for the long term, while leaving the rest to trade with. Wash, rinse, repeat.
If you are gambling though, just send your money to me. You’ll get the same return.
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