The stock market is a great option for those looking to invest due to its history of high returns and attractive tax benefits. However, the sheer volume of options (there are over 2000 Australian listed companies!), and different investment strategies, can make investing in the stock market complex and confusing for those without extensive knowledge or experience.
Here are several golden rules to investing that can help guide investors to grow their wealth successfully in the stock market.
Make informative and educated investment decisions
The most successful investors are those who are able to consistently make rational and informed decisions based on solid facts, research and information. Avoid making irrational investment decisions based on emotion, and instead stick to a sound and proven investment strategy.
The most successful traders go back to the basics and make a qualitative judgement on entry and exit points based on macroeconomic sentiments, price actions and volumes.
Know why you are buying shares in the company
Identify what type of investor you are (risk aversion, time horizon and investment objectives) and find a solid investment strategy which aligns with your investor type. Avoid the ‘herd mentality’ and don’t just follow the crowd when making an investment decision as it may not be the best option for achieving your initial investment objectives. The only time when this type of behaviour can be beneficial is if an investor is able to predict market sentiment for a particular stock or sector, and utilise an entry and exit strategy where he or she is able to both get in and out before the majority.
Have patience and discipline
To gain the best returns from your investments, it’s important to be patient and not make rushed decisions based on short downturns. This is especially important for any long-term investments, where it’s important not to speculate too much on day-to-day price fluctuations and focus instead on the stock’s fundamental true value. Discipline is another important factor when choosing which stocks to invest in. Avoid buying shares at all-time highs that may be well above your personal valuation and pricing belief just because you don’t want to “miss out.” When stock prices are at all-time highs, the chances are that there may be more downside risk, compared to upside return potential; and this is something investors must always keep in mind.
Invest in quality companies with great future prospects
The key to investing successfully in the stock market is by identifying companies with great future prospects, otherwise known as, Value Investing through Fundamental Analysis. Value investing aims to ensure healthy returns by investing in a company at an undervalued price, waiting for the market to realise the true value of the company, and then for the share price to increase in response. Fundamental Analysis is used to determine the valuation of a stock by focusing on the underlying factors that affect a company’s business and growth prospects, using historical and present data from various sources. In scanning through the market and compiling your watch list of stocks to trade, the first rule of thumb for any trader is to identify high volume, liquid stocks that are volatile with its price fluctuations. Look out for unusual volume activity and then inspect its source; perhaps an announcement may have been released or there were changes in macroeconomic factors. The next step would be to analyse if the unusual volume is reflected in the stock price. When the price action is correlated with the market depth backed by high volumes, it may signal the start of a strong trend, giving rise to a potential trading opportunity.
Have an exit strategy
When it comes to investing, timing in the market is everything. When an investment trend comes to an end, investors should look to step out and lock in a profit before the potential of a late exit occurs where a significant value on the stocks could be lost. Determining the ideal exit point for is largely dependent on you investment time horizon. For example, day traders should enter into an opportunity when the rate of change of the buyers with respect to sellers has hit a turning point, whereby the buy orders are increasing at a faster rate. For traders with a longer time horizon, an initial analysis of the Relative Strength Index and MACD would be appropriate to indicate a suitable entry and exit point.
Invest only when there is an opportunity
Although every investor has their own methods and indicators to identify opportunities, there are some key factors which every trader should consider. Good entry points are purely dependant on momentum swings in market depth and this is where experience comes into play. A good rule of thumb is to always wait for confirmation that an uptrend is fully established before entering into a stock. It’s also a good idea to wait for signs of an increasing rate of buyer volumes.
Understand the business before investing
When it comes to investing, wealth begins with better knowledge. This is why having a solid understanding of how investing works is essential to being successful in the stock market.
While nothing can replace the years of experience an established investor has, educating yourself on key investment principals, strategies and trends will enable you to make better investment decisions. Don’t just ‘set and forget’ your investments either, make sure to keep up to date with industry trends and read any information sent to you by the companies you have invested in, paying particular notice of any takeovers.
Do not speculate
Many investors make irrational investment decisions that stray from their investment strategy due to psychological emotions like fear, greed, emotional attachments and herd mentality. When making decisions solely based on what the majority of the market is doing, investors often forget their initial investment objectives and purely assume that they themselves must be wrong. Allowing emotions to dictate key investments decisions can have negative impacts on overall performance, so it is important to not speculate and become caught up in any immediate hype, and instead make rational and informed decisions based on solid facts, research and information
About the Author
Michael Kodari is the founder of KOSEC – Kodari Securities, and is one of Australia’s prominent experts in the stock market. With a strong background in funds management and stockbroking, Michael has worked with some of Australia’s most successful value investors and consulted to leading financial institutions.