Choosing an Investment
There are several criteria for choosing an investment. These criteria are that a stock investment should make money. It should have a margin of safety so that adverse events such as stock market crashes do no wipe out years of gains. Choosing an investment often has to do with diversifying a stock portfolio in order to broaden opportunity as well as to reduce investment risk. Choosing an investment in a promising new stock, even penny stock investing, opens up the prospect of the occasional “home run,” the stock market investment that multiplies a hundred fold or more in value in just a few years.
Choosing dividend stocks with histories of solid, steady stock price appreciation is relying on the power of exponential growth. An investment that grows at 14% a year, for example, will double in value in five years. With a secure investment, time is on your side as dividend checks arrive quarterly and stock price increases year after year. Investing in a company with a hundred year history of always paying dividends is not defensive investing. It is very commonly successful stock investing. Sometimes the best criteria when choosing an investment is whether or not you will be able to sleep at night.
Those who engage in long term investing will look for a margin of safety to help protect against loss. However, they will also look for growth potential. Ideally an investment will have growth potential overlooked by the stock market in general. Thus the stock price will be lower than what the company’s earnings potential should warrant. This is an ideal example of the value of fundamental analysis in stock picking. Choosing an investment in a stock with a low price to earnings ratio, for example, will often mean that the price will catch up to the earnings and the investor will profit.
Stock portfolio diversification tends to reduce the risk of loss in stock market investing. By choosing stocks in different market sectors the investor will reduce the risk of a market disaster in one sector taking down all stock values. In addition, by investing in a larger number of promising stocks the investor will increase his or her chances of picking a really big winner. For the average investor who has a full time “day job” it makes sense to hold up to half a dozen stocks. For the full time professional a larger number is possible. This simply has to do with the ability to do at least weekly fundamental and technical analysis of the stocks that one holds.
The Long term investor and the day trader need to buy, sell, or trade investments that they understand. If you don’t understand the investment don’t buy, don’t sell short, don’t’ touch it. This rule of thumb applies to technical analysis as well as the fundamentals. Traders who do not recognize a pattern in their Candlestick analysis should choose to “sit this one out.”