How to Invest in Stocks
Getting Started for New Investors
The stock market provides one of the highest investment returns available, but it can also be a little confusing or even intimidating to beginner and even novice investors.
This series of articles has been specifically written for beginner stock investors and provides the minimum basic information needed to start investing successfully.
So if you've been putting off investing in the stock market, the time to begin is now. Like any new endeavor it may not feel comfortable at first but that will pass as you gain experience.
Many successful stock investors treat investing as a hobby and unlike most hobby's that cost you money, this is one hobby that can significantly increase your future wealth.
It's not unusual for beginner stock investors to feel overwhelmed and not knowing where to start. After all, there's a lot of conflicting advice floating around, so we are going to keep things really simple and focus on the things that work over the long-term. This will allow the beginner stock investor to develop good long-term investing and financial management skills.
We take a common sense approach that is based on many years of investing in the stock market.
Setup an Investment Plan
Building wealth takes time and beginner stock investor's should start with basic passive investing and hold their investments for the long-term (preferably 10-years or more).
As the beginner stock investor gains some experience they can then manage their portfolio for the market cycles. This can involve reducing or even exiting their portfolio in adverse market conditions and restating their portfolio for the next market cycle.
A time proven method for stock investors to build their wealth is to regularly invest their surplus cash. This can be done monthly, quarterly or even annually.
Regularly adding money to the market is a fantastic way to significantly increase your portfolio worth as the magic of compounding returns works in the stock investors favor.
To participate in the stock market is very simple. All the stock investor needs to do is either buy some shares of public companies (we call these stocks) or buy a Fund (which owns the stocks).
The beginner stock investor can now carefully consider the following topics and setup their own investment plan.
Investment Plan Considerations
The first step is to consider your investing time frame.
- If more than 10-years consider holding stocks only.
- If less than 10-years and more than 5-years you should consider including bonds within your investment portfolio.
- If less than 5-years consider investing a large portion into bonds (such as 75%).
- The second step is to consider whether you are going to make regularly contributions to your investment portfolio or whether you just want to invest an initial lump sum with no further contributions. Regular contributions (also known as dollar cost averaging) can be made monthly, quarterly or even annually. The initial investment amount can be any size but there are some practical minimum limits.
- The next consideration is whether to invest in stocks, funds or bonds. To a certain extent this is a personal preference, however the beginner investor should be aware of the brokerage costs for buying stocks and the management fees for owning funds. Another consideration with Funds is the minimum initial investment required. Also beware that brokers generally charge a brokerage fee if buying funds.
- If you are employed you should consider contributing to a 401(k) or other employer sponsored plan where the employer co-contributes. Depending on the employer you may get $0.50 or even a dollar for every dollar you contribute, and there are tax advantages. They are great for long-term investing into the future, but they are a retirement plan so if you need to withdraw your money before retirement a retirement plan may not suit your financial goals.
- US residents should consider whether an IRA (Individual Retirement Account) suits them. Again there are tax advantages which makes them an efficient strategy for building future wealth but they are also a retirement plan.
- You can use a conventional investing account (which does not have any tax benefits) if the 401(k) or IRA do not suit or if they do and you have more money to invest. With a conventional account you can withdraw money at any time without penalties.
- You will need to open an account with a stock broker to buy stocks. Most brokers have both IRA and conventional account types. Employers will generally set up 401(k) accounts but the self employed can set up their own.
- Funds can be bought through most stock brokers but they generally charge a brokerage fee. Funds can also be bought directly from the company that operates the Fund without a brokerage fee. You will first need to open an IRA or conventional account with the fund company as this account is used to buy the Fund. If you are only investing in Funds and buy them directly from the fund company you do not need a stock broker.
- Beginner investors do not have to start fully invested. You can start with any amount you like. Some beginner investors feel more comfortable starting slowly. You can always invest more money at a later stage as your confidence increases.
An important consideration that needs to be discussed is the size of the initial investment.
Initial Investment Considerations
Starting with $100
Beginner stock investors starting with very small accounts like $100 have very few options. There are a handful of Mutual Funds with a $100 minimum initial investment. Buying stocks will cost way too much in brokerage and most Funds have minimums significantly higher than $100.
Starting with $2,500
Beginner stock investors starting with small accounts with a minimum of $2,500 should probably start investing the full amount to begin with. When buying stocks the investor would ideally buy 10 stocks which means a minimum of $250 per stock. The brokerage will be around $7 using an online broker (which represents a reasonable 2.8% of the stock value). When buying Mutual Funds a lot of funds have $2,500 to $3,000 minimums so the investor has a plenty of funds to pick from.
Starting with $10,000
Beginner stock investors starting with a moderate account size of $10,000 could start investing the full amount but if buying stocks they should consider starting with maybe halve and consider buying say 5 stocks to begin with and add some more latter as their experience and knowledge increases. If only buying funds consider investing the full amount.
Starting with $100,000
Beginner stock investors starting with large accounts of $100,000 or more should consider starting by only investing a portion to begin with (maybe 25% or perhaps 50%) and increase the amount invested over time as your experience and knowledge increases. Large accounts can easily accommodate stocks and Funds.
The following article How to Select Stocks and Funds provides the beginner investor with some stock and fund ideas and you can consider whether they would be suitable for inclusion in your portfolio.
If you are going to regularly contribute to your investment account there a few things to consider if buying stocks.
Most Mutual Funds do not have any restrictions with contributing to the fund after the initial purchase. So the investor can add any amount at their desired interval.
However with buying stocks there are some practical limitations. The brokerage cost is around $7 to $10 using an online broker and the stock price needs to be considered.
Contribution Considerations with Stocks
Adding $20 per month
Realistically you will have to wait until you have accumulated several hundred dollars in your account before you could buy some shares in one stock. If you bought one share of a $10 stock it will cost you upwards of $10 to buy it. Now that's 100% of the initial cost meaning the stock price would have to increase 100% just to break even. Realistically you would have to accumulate around $300 first and buy 30 shares in that $10 stock (the brokerage would now only represent around 3%).
Adding $100 per month
Similarly you will have to wait some months until you have accumulated several hundred dollars in your account before you could buy some shares in one stock. Buying one share of a $90 stock will cost around 10% of the purchase price. But if you wait and accumulate $300 you could buy three shares of the $90 stock and brokerage would only cost around 3%.
Adding $500 per month
You have enough to buy a stock or maybe two. The brokerage cost will be a few percent which is reasonable. As the months go by you should buy a variety of stocks so that your portfolio remains diversified. In other words "don't put all your eggs in one basket".
With the smaller contributions you should seriously consider adding to a Mutual Fund as the brokerage costs with buying stocks becomes excessive which significantly diminishes your net returns.
The article How to Select a Stock broker. provides some guidance for the beginner stock investor in selecting a stock broker (if you require one).
Passive Investing vs. Active Investing
Passive investing means buying stocks and/or funds and holding these for the long-term (generally 10-years or more). Most passive investing strategies involve managing a portfolio for the market's cycles.
Active Investing involves actively monitoring and managing a portfolio during each market cycle and requires more time from the stock investor. Active investing is best done by investors with some experience in the markets.
With passive investing you are investing for the future value of the companies. Stock prices can be quite volatile in the short-term and these prices are best ignored by the beginner stock investor who should keep their focus on the future rather than on the present.
Most of the stock investors that are still around today who started a decade ago are those with a long-term portfolio who applied portfolio management strategies.
Speculation and Trading
This guide has been written for beginner stock investors who are looking to invest for the long-term and is not appropriate for speculation or trading.
Speculation and Trading is highly active and requires a considerable amount of time.
The potential for profits is high but there is a real possibly of substantial financial loss. Speculation and Trading is high risk and its best if beginner stock investors refrain from these until they are more experienced.
What To Do Next
Now that you have a better understanding of investing it's a good idea to write down your own investment plan using the above information as a guide.
Always keep in mind your own personal goals and don't be influenced by other people as their objectives are probably different to your own.
Once you have your written investment plan, the next step is selecting the stocks and/or funds for your portfolio.
The following article How to Select Stocks and Funds provides some stocks and funds for you to consider and you can decide whether they are appropriate for your investment plan.
How to Select Stocks and Funds
What To Invest In
Hopefully you have setup your investment plan which was discussed in the previous article Getting Started for New Investors and if you haven't now would be a good time to do so.
Your investment plan should state your time-frame, your initial investment amount, your contributions (if any) and hopefully what you are planning on investing in such as stocks, stock funds or bond funds.
If you are finding it difficult deciding between stocks and stock funds there's more information later on in this article.
This guide on selecting stocks and funds is written to provide the beginner stock investor with the safest investments to start with. These are common sense suggestions based on many years of market experience.
The main theme for beginner stock investors is to follow the markets performance.
Beginner stock investors who become overly ambitious with advanced strategies statistically end up losing money. They become discouraged and subsequently close their account at a loss. Sadly this is an all too common scenario.
In order to become a long-term investor who is actually still around in a decade's time you really need to start slowly and safely.
As your experience and knowledge increases you can then incorporate the more active strategies into your portfolio - impatience only leads to losing money.
The following is general advice for the beginner investor when selecting stocks to buy.
Investment Plan Considerations
- The beginner stock investor should focus on becoming part-owners of good businesses rather than riding the short-term stock price movements up and down. You can always do that when you have gained more experience.
- Don't put all your eggs in one basket. Rather you should spread your investing across a variety of stocks - if one stock performs poorly chances are that another stock will perform strongly to offset the poor performer. This balances out your risk.
- Buying around 10 stocks is appropriate for the beginner investor. They can be all bought to start with or you can buy one or more at a time over a period of months.
- Generally it's a good idea to pick stocks from different industries rather than picking too many stocks from the same industry, for example a lot of bank stocks.
- For beginner stock investors it's the safest to buy large companies rather than small companies. This means buying large-cap stocks especially the blue-chip stocks.
- A good place to start is with the 30 blue-chip stocks that make up the Dow Industrials index. These are 30 of the largest companies in the world and they normally pay Dividends which is great for beginner stock investors - you get capital gain and dividend cash payments to boost your return.
- For any stocks that you are considering buying it's a good idea to first read the stock reports that are provided by your stock broker.
The table below shows the 30 blue-chip stocks that make up the Dow Industrial Index (based on Nov 15, 2016).
Table 1. Stocks in the Dow Industrial Index
Table 1. above shows the 30 blue-chip stocks that make up the Dow Industrial Index. The stocks are sorted by their dividend yield (based on the previous 12-months of dividend payments) and the data is based on Nov 15, 2016.
The beginner investor building a portfolio of stocks would ideally start with 10-stocks. While you could pick any stocks you like you should consider stocks that are both relatively safe to start with and pay dividends.
A simple approach is to select 10 good dividend yielding stocks from the Dow Industrial index. This is an easy way to get started and as you gain experience you can replace some of these stocks with other stocks.
Historical analysis has shown that no matter what 10 Dow Industrial stocks you pick, your portfolio value will still broadly follow the direction of the Dow Industrial index (it might perform slightly better or perform slightly worse than the index, but it will still broadly follow the index cycles up and down).
While the beginner investor could select other stocks outside of the top 30 blue-chip stocks the risks start to increase. If you do select stocks outside the top 30 then it's best to buy large-cap stocks within the S&P 100 index. These are the 100 largest stocks and include the 30 Dow Industrial stocks.
As always - Remember it's best to kept it simple and safe when you first start investing.
Some beginner stock investors do not feel comfortable picking the stocks to include in their portfolio. These investors basically have two options - Buy a Stock Fund (which owns a portfolio of stocks and is discussed in the following topics) or use a broker service which sets up a portfolio of stocks for you.
There are a couple of different broker services available and the one discussed here is where the broker sets up a portfolio for you (which includes actually buying the stocks). These broker portfolios have various names (such as Managed Portfolio) depending on the broker.
Of course these services are not free and costs vary significantly but to give you an idea the fees tend to be around 1% per year. The cheaper ones are provided by online brokers.
One important consideration is that all of these broker portfolios have minimum account sizes. The minimums vary significantly with some as high as $100,000 and some as low as $5,000.
Buying Mutual Funds
If you are looking to buy mutual funds you should be aware of the fees they may charge - which can be quite significant.
History continues to show that the high fee funds do not perform any better than the low fee funds - they just cost the investor more to own.
Keeping this is mind you really should consider low fee funds - which are referred to as "No Load Funds".
Another consideration is Index Tracking (with low fees) verses Actively Managed (with high fees). Again history has shown that after fees the returns from actively managed funds have been disappointing.
Again keeping this in mind the beginner investor should seriously consider starting with a No Load Index Fund.
The main providers of No Load index tracking mutual fund are Fidelity and Vanguard. These funds have relatively high initial investment minimums. A low $100 minimum initial investment fund is provided by Schwab.
Table 2. below gives a list of mutual funds that track the S&P 500 index (data based on Nov 15, 2016).
Table 2. Stock Index Mutual Funds
Table 2. above provides a selection of No Load Index Mutual Funds with varying minimum investments and fees (Expense Ratio). The fees are all quite low but are lowest with the higher initial investments of $10,000. These Mutual funds generally attract an annual $20 account service fee for balances under $10,000.
If you are looking to include some bonds in your portfolio the easiest way to do so is to buy a bond mutual fund.
The same principle of low fee No load also applies to bond mutual funds. Hence we will only look at No load funds.
While the investor could consider a combined stock and bond mutual fund, these tend to have high annual fees together with an additional entry fee (Load funds). These funds will not be considered for this article.
With bonds it's safest to invest in Treasury bonds. Since the beginner stock investor who is including bonds has no doubly done so for its safety, we will only consider mutual funds investing in treasury bonds.
Table 3. below shows a list of U.S. Treasury Bonds mutual funds (data based on Nov 15, 2016).
Table 3. Treasury Bond Mutual Funds
From the above table the Schwab bond fund is the most expensive to own but it has a low $100 initial investment. Obliviously if your initial investment were $2,500 or more you would consider one of the other funds in the list with a lower fee.
If you want bonds and still prefer owning U.S. Treasury bonds directly then another possibility is to buy them directly through treasurydirect.gov. These are newly issued Treasury bonds which are sold in $100 lots and you will need to open an account with them to buy their bonds.
How to Select a Stock Broker
The investment plan setup by the beginner stock investor should state what types of investments to include in their portfolio.
A stock broker is required if you want to buy stocks or you prefer to buy mutual funds through a stock broker rather than buying directly from the fund provider. If you need a stock broker then this article will help you select a broker.
The beginner stock investor essentially has two options - a Full Service Broker or an Online Broker.
Full Service Brokers
The full service broker is the traditional stock broker that has been around for as long as the stock market.
A full service broker sets up and actively manages an investor's portfolio. They do all the buying and selling and make all the decisions. This makes them appealing to stock investors who do not want any involvement with the stock market.
Their service is however predominately aimed at large accounts starting at $100,000 even though there are some services available for smaller accounts.
While they provide a full service this service is relatively expensive and actually reduces the stock investor's long-term net returns. They charge an annual portfolio management fee and also charge relatively high brokerage fees to buy and sell stock.
Apart from the relatively high costs, stock investors never really learn anything about investing in the stock market since they leave all the decision making to the full service broker. Also keep in mind that they work on commission. If the portfolio value drops then so does their management fee. So to make it up they may try to get brokerage from you by convincing you to sell your stock even if you should keep it.
For beginner stock investors with small accounts, if you have trouble making decisions or don't want to make decisions then it's a worth considering buying mutual funds. They can be bought through most stock brokers or you can buy directly from the fund provider.
Another option for stock investors with accounts over $25,000 is a passive managed portfolio from a full service broker where the broker sets up the portfolio only and does not provide the ongoing active management. This leads to a lower annual fee but is still a fee that could be avoided if the investor bought the stocks themselves.
If you are interested in using a full service broker you can explore the websites of Charles Schwab and Fidelity. These two brokers also offer online brokerage accounts.
Online brokers are relatively new and their popularity has soared along with the popularity of the internet. In fact the majority of personal stock investors use online brokers nowadays.
Many of the modern day personal stock investors are self-directed and the brokers of yesteryear no longer suit their investing temperaments.
Several factors helped fuel their popularity of the online broker and these include low brokerage fees, none or little ongoing annual fees, and the stock investor can make their own decisions.
With an online broker the stock investor makes the buying and selling decisions based on their own research.
Most online brokers now offer some form of semi advisory service. They either charge an additional brokerage fee or they charge an advisory fee based on the portfolio value (with account minimums from $5,000).
Generally most self directed investors prefer to make their own decisions but beginner stock investors should only open a cash account and not a margin account.
Buying stocks with borrowed money is best done by experienced investors, so for now it's best not to use borrowed money - you can always include a margin account when you are more experienced.
Also brokerage commission and fees are costs that reduce the return on your investment - so it's a good idea to keep these as low as possible so your net return is as high as possible.
Online Broker Comparison
The table below shows a list of the major online brokers (this is not a complete list but it does give the beginner stock investor a starting point).
Table 1. Online Broker Comparison
None of the brokers have Monthly or annual fees but they still have other fees (which may or may not be applicable). The brokerages for stocks range from around $7 to $10.
The account minimums vary considerably and may well be the deciding factor for those beginner stock investors with small accounts. Buy keep in mind that these are opening balances.
The online brokers from Table 1. are listed below along with their websites.
Online BrokersCharles Schwab
Invest in stocks, mutual funds and bonds.
Some mutual funds are free, others $76 to buy and $0 to sell
Invest in stocks, mutual funds and bonds.
There are some free trade benefits starting with opening account balances over $10,000 and discounts but these are aimed at frequent traders.
Invest in stocks, mutual funds and bonds.
Some mutual funds are free, others $49.95 to buy and $0 to sell.
Invest in stocks, mutual funds and bonds.
Some mutual funds are free to buy while others cost $17 to buy.
Some mutual funds are free to sell while others cost $17 to sell.
Website scottrade.comTD Ameritrade
Invest in stocks, mutual funds and bonds.
Some mutual funds are free, others are $49.99 to buy or sell.
The next step is to check the website of the online brokers you may be interested in and see which one if any suits your requirements.
Understanding Market Cycles
Investors new to the stock market can be broadly categorized into two types.
First there's the optimistic stock investor who's under the impression that the market only goes up and second there's the pessimistic stock investor who's under the impression that the market only goes down and is especially fixated on market crashes.
Both are right and wrong to a certain extent. The stock market actually cycles - which means it alternates up and down.
Stock Market Cycles
This cycling action occurs in two broad directions.
Two Broad Market Directions
- The first is where the market bounces up and down and broadly heads higher. This market phase is referred to as a bull market and can last from two to ten years.
- The second is where the market bounces up and down and broadly heads lower. This market phase is referred to as a bear Market and usually lasts from six months to a year or two and on rare occasions three years or more.
As time goes on over the decades the market broadly cycles between bull markets and bear markets as it works its way higher.
This market cycling behavior is illustrated in Graph 1. below.
Graph 1. Stock Market Cycles
The graph above illustrates the stock markets basic behavior which shows a bull market (label A to B) followed by a bear market (label B to C) followed by the next bull market (label C to D).
Looking at the first bull market (label A to B) we can see that this is not a straight line up but actually contains an alternating up and down cyclic action. The points labeled RH stand for Relative High and the points labeled RL stand for Relative Low.
The Bull Market Cycle
- The bull market starts with the first advance higher from label A to the first RH. This is where the market first goes up and is referred to as a Rally.
- This now reverses and the market sells down from the first RH down to the next RL. This is where the market goes down and is referred to as a Pullback (some stock investors prefer to call pullbacks a correction).
- The next advance begins from the RL and the market rallies up to the next RH.
- The next pullback occurs and the market sells down from the RH down to the next RL.
This alternating rally and pullback action continues for as long as the bull market lasts. This is the basic market behavior of a bull market.
Looking at the first bear market shown on Graph 1. above, we can see that this also does not travel in a straight line but shows the same up and down cyclic action that the bull market showed. However the rally and pullback action is now working its way lower instead of higher.
The Bear Market Cycle
- The bear market starts with the first decline lower from label B to the first RL within the bear market. This is where the market first goes down and is referred to as a Correction.
- This now reverses and the market rallies up from the RL up to the next RH in the bear market. This is where the market goes up and is referred to as a Bear Rally.
- The next decline begins from the RH and the market sells down to label C. This is the end of the bear market as shown in Graph 1. but some bear markets show a another correction and bear rally.
This alternating correction and bear rally action continues for as long as the bear market lasts. This is the basic market behavior of a bear market.
Some bear markets are minor and only show one big decline from label B to C without any RL or RH. A minor bear market is referred to as a market correction and may simply be called a correction.
While Graph 1. shows normal market behavior, the bottom of bear markets (label C) can be at or in very rare cases even slightly below label A. Also in rare cases the top of a bull market (label D) is at or even below the top of the preceding bull market (label B).
When the beginner stock investor first starts investing they could have started at any point in Graph 1. They may have started at label A or at label B or somewhere between. Over the long-term it really does not make that much difference as the markets long-term direction is upwards.
While the stock investor makes a capital gain over the long-term no matter where they started, the annual returns do vary.
Bear markets reduce the return and that's why we generally incorporate passive investing and active investing strategies to deal with bear markets.
The Stock Market's Performance
As you have learnt by now the stock market cycles its way higher over the decades with a never ending sequence of up cycles (we call these bull markets which last two to ten years) followed by the smaller down cycles (we call these bear markets which usually last one to two years).
The net result is that the stock market works its way higher over the long-term and this is the reason why stock investing is best viewed as a long-term proposition.
The stock market performance is measured with indices which are nothing more than calculating an average gain for a selection of stocks over a period of time and plotting this on a chart.
The two most popular indices are the Dow Industrial Averages (which contains 30 Blue-chip stocks) and the S&P 500 (which contains 500 of the largest stocks).
Plotting these indices on a chart provides the stock investor with a visual representation of the markets behavior.
Stock investors can view the Market Cycles from the last 100 years through a series of articles.
Chart 1. below shows the performance of the Dow Industrials since 1975.
Chart 1. The Stock Market's Performance
Chart by stockcharts.com
The above chart shows numerous points labeled 1 to 8. These highlight some important points in the stock markets recent history.
Dow Industrials Recent History
- Label 1. In Jan-1975 the Dow is at 619
- Label 2. In Aug-1987 the Dow reaches 2,701
- Label 3. In Oct-1987 the Dow drops to1,739 (the market Crash of 1987)
- Label 4. In Jan-2000 the Dow reaches 11,722 with a few minor corrections in between
- Label 5. In Mar-2003 the Dow drops to 7,524 (includes the Tech Wreck of 2000)
- Label 6. In Oct-2007 the Dow reaches 14,164
- Label 7. In Mar-2009 The Dow drops to 6,594 (the Financial Crisis of 2008)
- Label 8. As of Nov 18, 2016 the Dow is at 17,737 (includes the market correction of 2015)
Even though the stock market cycles through bull markets and bear markets the long-term direction is upwards.
It's not uncommon for beginner stock investors to worry if they start now. Their concern is that the market will turn bearish and decline. This is false reasoning as the market always cycles between RH and RL whether its a bull or bear market, so in the short-term it is most likely that you will experience a decline.
Even if the bear market starts now they are short lived before the next bull market cycle begins.
If you wait the market will take off without you and may never come back. Your focus should be on the future value of your portfolio and not on the present value.
Rather than not participating, it's better to understand the stock market's cyclic behavior so that the beginner stock investor is prepared for the inevitable market swings and corrections that occur to interrupt the market's advance.
The Dow Industrials over the 42 year period shown on Chart 1. above went from 619 to 17,737 which is nearly a 3,000% increase with a compounding annual capital gain of over 8% per year plus there's another couple of percent for dividends.
Should You Trade
The illusion of Trading
A common trap for beginner stock investors is to watch the market prices daily. To a certain extent this is understandable as the beginner stock investor is keen and eager to see their newly purchased portfolio increase in value.
The problem with doing so however is that the stock market does not go up in a straight line but zigzags and bounces around considerably with market cycles as it works its way higher.
This means that the portfolio value can easily drop below the initial purchase price and do so numerous times during a bull market, and will most likely drop below the initial purchase price during a bear market.
The beginner stock investor sees their portfolio value go up initially but then soon afterwards its value drops below the initial purchase price.
This leads some beginner stock investors to believe that it's better to sell their stocks as soon as they show a small profit. They also learn a basic principle of trading which is to sell their losing stocks as well.
Thus the beginner stock investor has effectively changed from an investor into a trader who has no market experience. Unfortunately, history shows that the outcome from here on is that of losing money.
Trading requires market experience and knowledge and it's an activity best left until the beginner stock investor has more experience.
Chart 1. below shows where a beginner stock investor who watches the market daily might have sold their stock after a quick initial gain before dropping below its purchase price.
Chart 1. Stock Trades Below Purchase Price
Chart by stockcharts.com
Referring to Chart 1. above, the beginner stock investor initially feels good that they have stopped their portfolio from further declines. The problem with this logic is that it only takes into account the present value and ignores the whole point of investing - which is to invest for the future value.
The buy and sell dates shown on Chart 1. above are taken from a decade ago. Chart 2. below shows how this stock performed over the last decade since the stock was sold at label B.
Chart 2. Long-Term Potential Gain
Chart by stockcharts.com
From Chart 2. above, the Buy (label A) and sell (label B) are the labels A and B from Chart 1. which shows how insignificant the initial decline was.
Referring to Chart 2. the stock after having been sold at label B ran up to the October 2007 bull market top, then dropped below label B at the bottom of the bear market in March 2009 before running up in price during the current bull market.
While it's true some stocks drop in price and never recover, these tend to mainly occur with the smaller stocks - especially those struggling with making a profit.
That's why it's generally safer to invest in larger stocks that are operating at a profit. These are the stocks that tend to increase in value over the long-term.
The beginner stock investor should keep in mind that the most a stock can go down in value is 100%, but a stock can go up by much more than 100% over the long-term. There are plenty of stocks that have increased 1,000% and more.
The point is that over the long-term a stock price can go up far more than what it can go down. The most a $50 stock can go down is $50 but it can go to $500 and more - there's no physical limit to how high the stock price can go.
So You Still Want to Trade
Trading is the process of buying a stock with the intention of selling it soon after buying it - hopefully for a profit.
Chart 3. below shows how a trader would have traded the stock from Chart 1. using the purchase price at label A.
Chart 3. Short-Term Trading
Chart by stockcharts.com
The trade shown above in Chart 3. is a short-term trade using a daily chart. The trade used a $1.00 profit target with a $0.30 risk stop-loss. This means the trader either sells at $13.30 for a profit or sells at $12.00 for a loss. In this case the trader sells for a profit but there are plenty of times where the trader sells at a loss.
Short-term trading is an activity that looks simple, but in reality is far more difficult and is only suited to those with market experience and knowledge.
Experienced stock investors may use short-term trading to boost their investment returns but their main strategy is still long-term investing.
Beginner stock investors don't realize that short-term trading actually involves a lot of work and its very time consuming. A large portion of their weekly spare time is spent with short-term trading duties - it's more like a second job.
In a decade's time, most beginner stock investors who started with short-term trading and didn't include a long-term investment portfolio ended up regretting their decision.
Beginner stock investors who start trading should seriously considerer also including a long-term investment - even if they only buy an index tracking fund. At least the beginner stock investor will receive a long-term capital gain with dividends and they will receive this regardless of how their short-term trading ended up performing.
Trading is generally a short-term activity but it can also be used with a long-term approach.
For the beginner stock investor who still wants to trade a safer approach is to use the long-term trading strategies. This way the beginner stock investor is at least following the bull market higher and they can sit on the sidelines during bear markets.
Chart 4. below shows the stock from Chart 3. The long-term trader buys the stock but sells it at a loss and then buys it again and sells it for a large profit. The trades are shown using a weekly chart.
Chart 4. Long-term Trading
Chart by stockcharts.com
Referring to Chart 4. the long-term trader buys at the same price as the short-term trade from Chart 3. The long-term trade here used a 10% initial stop which means the stock was sold when it traded below $11.05. The long-term trader then buys the stock again as it trades higher at $11.90 and places a 10% initial stop at $10.70.
This time the stock does not trade below its stop and continues higher with the bull market. The stock is finally sold because the Dow Theory triggered a possible market correction.
Long-term trading is more like active investing as the longer time-frame rides the bull market higher whereas the short-term is very volatile even in a bull market.
During bear markets the long-term trader can always remain inactive and wait for the next bull market to begin.