Learning Your Craft: Investing & Trading
Many people have aspirations to “learn how to invest” and to learn how to pick stocks and understand the markets better. Most have no idea how to approach this. Your 20s are a fantastic time to pick up other skills and abilities. One of the most lucrative skills that you could pick up is the ability to become a more successful investor or trader.
There are some key things you should master in order to become a mildly successful investor (excelling past basic success requires time and continuous learning). We will look at each of them in this article.
Understand How The Market Works
Nothing is more important than this. Let’s start at square one. Stocks represent equity in companies. When you buy a stock, your money is not transferred to the company. In fact, the share price of a company really doesn’t have much effect on the actually company’s operations (except in cases of additional capital raising, employee morale, etc.). When a company wants to raise money, they sell ownership to the public in the form of shares of stock. Once these shares are on the stock market, they are now in a public market, exchanging hands between individuals and institutions. When you buy a stock, someone else is selling it. It’s a market.
Now that you have the basics down, even more importantly is to understand what fuels the movements in share price up and down. Fundamental investors attempt to buy or sell based on fundamentals. These might be earnings announcements, management changes, strategic partnerships, new products, etc. All things that involve operations at the company that will potentially help or hurt the ability to earn money. Earnings announcements can often drive a share price.
On the technical side, many traders monitor technical indicators even more so than the fundamental indicators as described above. By following the chart patterns and movement trends, traders attempt to predict where the stock is heading. They get in and out much quicker than a long term fundamental investor.
The Stock Market Is Not Reality
This is a point that most people learn through painful experiences or losing some money. The stock market isn’t reality. For example, our economy has continued to get worse in 2009 with unemployment going over 10%. The stock market has rallied 60%. Most people brush this off as “forward looking” and there is some truth to that. But even more important is the fact that the stock market does not replicate reality. It replicates people’s perception of reality. I repeat, the stock market replicates a perception of reality, not actual reality. Because of this, the stock market can be “wrong”. Now, over time the stock market usually corrects to a closer replication with true economic reality, but it can be crazy how long the market can be “wrong”. This is usually in the form of bubbles, preceding major crashes that nobody sees coming.
Long Term Investors: Buy on Yield, Not on Price
A great way to find buying opportunities is to buy a company based on the dividend yield. A yield is a function of the share price and the dividend payment (P / SP = Y). As such, when share price drops and dividend payment stays constant, the yield will go higher. Whatever the yield is when you buy the stock, you lock in that yield no matter what the share price does because you are calculated your yield or return based on money invested, not on market value. Therefore, lock in larger yields and you will have larger returns over time.
Many experts look for real market bottoms by looking for high yields. Obviously, bottoms are when you want to invest. Most people remember that we should buy low and sell high. That is correct, but you should also remember to buy low and lock in a high yield.
For another article in the Learning Your Craft series, check out Learning Your Craft: The Business of Blogging.