How to Beat the Stock Market?
Fundamental & Technical Investing in the Stock Market
With the advent of online trading many investors have become ‘day traders’ operating from the comfort of their home office. They buy and sell shares by using various types of software available in the market. Most of these people are engaged in technical investing. Though ‘day trading’ strictly cannot be termed as investing, if the aim is to create passive income. It is good for generating cash flow if done properly.
A truly knowledgeable and sophisticated investor takes investment decisions after doing both fundamental and technical analysis of an asset.
This involves careful analysis of the following:
- Financials and future earning potential of a company
- Economic outlook with especial focus on country and state where the company is located
- Economic outlook of the specific industry in which the company is involved
- Direction of interest rate movement
These days, markets fluctuate wildly because news travels at lightning speed and gets amplified through multitude of news outlets. This affects the market sentiments of both buyers and sellers. It is because of this more people are turning towards technical analysis. They prefer short-term trades as against investing for long-term. Technical analysis involves the following:
- Analysis of emotions of the market
- Supply and demand of company stock
- Look for discounted prices of a stock based on sentiment
- Study of pattern of share price movement
- Study volume trends of sales and purchases of a stock
Fundamental analysis is a must if you wish to invest for long-term. This is what Warren Buffet does best to create long-term wealth. Technical analysis, on the other hand, is more suited for short-term trading. Whether you are long-term investor or a short-term trader it is advisable to use both the analysis methods. This will not only maximize investment returns but also reduce risk.
Outside and Inside Investors
Most people are outside investors. They make their investment decisions based on financial reports released to the public as a part fiduciary responsibility of a corporation.
An inside investor is the one who has some degree of management control of a company. He has greater knowledge regarding the future plans and problems within a company. This knowledge is extremely important to reduce risks and increase returns.
You can become an insider either by building your own company or buying controlling interest in a company.
Being an inside investor should not be confused with SEC definition of an “insider”. According the law “insider trading” is illegal if one profits from company information that is not public.
The difference is that an inside investor has control over direction and operations of a company. An outside investor does not and is therefore limited in his capacity to change things.
Concentration Vs Diversification
Study the two statements below carefully:
“Do not put all your eggs in one basket.” -Proverb
“Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.” Warren Buffet
This is why investing can be so confusing for many investors. Your fund manager will advise you to diversify by investing into mutual funds and Warren Buffet will give exactly the opposite council to focus only on few investments. Both advices are true depending on your circumstance.
“Wide diversification is only required when investors do not understand what they are doing.” Warren Buffet
If you lack the knowledge of investing or do not have the time, then it is best to diversify by buying into mutual funds. It is best to seek advice from competent fund managers or better still invest on a monthly plan into an index fund.
“By periodically investing in an index fund, the know-nothing investors can actually outperform most investment professionals.” –Warren Buffet
Index funds are those that track share prices and are better because they have no loading costs. It has also been found that they perform better than most fund managers.
On the other hand, if you are a knowledgeable investor with limited funds at your disposal and wish to embark on path of accelerated wealth creation then it is best for you to focus on one or maximum two wealth creation strategies at a time. You can truly master only one of the two things at a time. You also greatly reduce risk by concentrating on few holdings.
Once you have mastered an investment technique, it takes very little of your time to repeat the process to maximize your profit. Building wealth can be a boring repetitive process once you have mastered a technique. Unfortunately, the human mind needs excitement and most people tend to lose focus as they want to try out new things. There is nothing wrong in exploring new ideas but one should not lose focus on things that are getting results.
Once your wealth grows, it is important to diversify to preserve your wealth. Concentration builds your wealth whereas diversification preserves your wealth.
We do a full circle from diversification in the initial stages when we lack knowledge, to concentration for accelerated wealth creation as we become more knowledgeable and finally go back to diversification to preserve wealth.
If you wish to become a knowledgeable investor whether it is real estate, stocks or businesses you have master the following:
- Financial Statements -Become an expert in reading and understanding Financial Statements such as balance sheets, profit and loss statements. These are important to understand financial health of a company and risks involved in investing in a company.
- Investment formulas – These help in calculating profitability and risks involved in an investment. There are software programs and calculators that help you with the calculations but you still need to understand what they mean in relation to an investment you are analyzing.
- Investment Vocabulary – Mastering investment vocabulary will help you in discussions with experts when analyzing an investment.