Having trouble making up your mind about what investment strategy to adopt? In this blog post, we’ll try to help you find the right approach for your particular personality, preferences and investment objectives. After all, there are many different ways to invest.
Let’s get right into it!
Trading based on technicals
As described by Warren Buffett’s mentor Benjamin Graham in his book “The Intelligent Investor”, trading in the market usually means buying stocks when the market has been advancing and selling them after it has turned downward.
Traders tend to rely on technical analysis and try to predict how a stock will behave by considering moving averages, support and resistance, trend lines, and momentum-based indicators for example. This approach is based on the idea that if a trader can identify previous market patterns, they can form a fairly accurate prediction of future price trajectories.
Trading based on speculation
Speculating basically implies making a bet about a stock’s future price (either expecting the price to increase significantly or sharply decline). Speculators tend to expose themselves to riskier investments in an attempt to achieve above-average returns. As explained by Investopedia:
“Investors and traders take on calculated risk as they attempt to profit from transactions they make in the markets. The level of risk undertaken in the transactions is the main difference between investing and speculating”.
Speculation is either based on long-term or short-term selectivity. As Benjamin Graham puts it in The Intelligent Investor:
- Short-term selectivity: “This means buying stocks of companies which are reporting or expected to report increased earnings, or for which some other favorable development is anticipated”.
- Long-term selectivity: “Here the usual emphasis is on an excellent record of past growth, which is considered likely to continue in the future. In some cases also the ‘investor’ may choose companies which have not yet shown impressive results, but are expected to establish high earning power later”.
Some speculators also bet against a company based on short-term or long-term selectivity. If they expect a company to report poor earnings, for example, they might purchase put options in order to profit from a potential decline in stock price.
Trading positions that are based on a positive outlook for a stock are called “long positions” and those based on bets against a stock are known as “short positions”.
Investing based on fundamentals
As mentioned in a previous blog post, fundamental analysis strives to identify the intrinsic value and fair price of a stock based on factors such as earnings, expenses, assets, and liabilities. This approach has both quantitative and qualitative aspects.
- Quantitative fundamentals to consider: Indicators such as return on equity (ROE), cash flow, price-to-earnings ratio (P/E ratio), and projected earnings growth (PEG).
- Qualitative fundamentals to consider: business models, competitive advantages, leadership and management, public sentiment, among others.
Investors who prioritize fundamental analysis are often called “value investors”, because they tend to invest in companies that they consider undervalued and underpriced. Value investing often involves holding on to stocks for prolonged periods of time for the opportunity to achieve significant returns, so investors who have this approach may adopt strategies and tactics like averaging down or dividend investing:
- Averaging Down: A common strategy used by long-term investors is “averaging down” or “buying on dips”. Basically, this consists of reducing the average cost of their investment in a stock they own by buying more of that stock at a cheaper price. This involves recurring investments and tends to increase the investor’s returns if the stock’s price rises.
- Dividend Investing*: Dividends are a share of the profits that a company makes. Investing in stocks that pay dividends can be a good approach for long-term investors because it provides the opportunity to earn passive income from holding on to stocks in addition to the potential growth in portfolio value from asset appreciation (have in mind, however, that asset appreciation and dividends are not guaranteed and that investing in stocks implies inherent risk due factors such as market volatility, for instance).
Many long-term investors also choose to reinvest the dividends they receive back into the stocks they own. By using Passfolio’s Dividend Reinvestment Program (DRIP), for example, you can have dividends automatically reinvested in the company or ETF that paid you the dividends – this may help compound your return on investment in a stock.
*Dividend paying stocks are like any other stocks, as they may lose value. There are additional risks associated with investing in dividend-paying stocks, including the risk associated with a company’s ability to pay dividends, and risks associated with interest-rate changes, among others.
*DRIP is currently in beta so we are offering it for free until we launch our Pro plan. When Pro is launched DRIP will be disabled until you enroll in Pro. Don’t worry – you will not be charged for anything unless you choose to enroll in Pro. You never have to worry about surprise fees with Passfolio. Please see important information about DRIP here.
There is no perfect approach
No solution is perfect and there is no guarantee that a particular investment strategy will deliver results – remember to choose an approach that best suits your personal preferences and investment objectives.
For instance, if you have a long-term investment horizon and don’t want to spend too much time thinking about your investments, dividend investing and averaging down could be for you. If you’re seeking greater short-term gains and have time to dedicate to perfecting a trading strategy, swing trading could be the best approach. There is no “one size fits all”.
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