Investment in the Stock Market

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Over the past few years the stock market has made substantial declines. Some short term investors have lost a good bit of money. Many new stock market investors look at this and become very skeptical about getting in now.

If you are considering investing in the stock market it is very important that you understand how the markets work. All of the financial and market data that the newcomer is bombarded with can leave them confused and overwhelmed.

The stock market is an everyday term used to describe a place where stock in companies is bought and sold. Companies issues stock to finance new equipment, buy other companies, expand their business, introduce new products and services, etc. The investors who buy this stock now own a share of the company. If the company does well the price of their stock increases. If the company does not do well the stock price decreases. If the price that you sell your stock for is more than you paid for it, you have made money.

When you buy stock in a company you share in the profits and losses of the company until you sell your stock or the company goes out of business. Studies have shown that long term stock ownership has been one of the best investment strategies for most people.

People buy stocks on a tip from a friend, a phone call from a broker, or a recommendation from a TV analyst. They buy during a strong market. When the market later begins to decline they panic and sell for a loss. This is the typical horror story we hear from people who have no investment strategy.

Before committing your hard earned money to the stock market it will behoove you to consider the risks and benefits of doing so. You must have an investment strategy. This strategy will define what and when to buy and when you will sell it. 

History of the Stock Market

Over two hundred years ago private banks began to sell stock to raise money to expand. This was a new way to invest and a way for the rich to get richer. In 1792 twenty four large merchants agreed to form a market known as the New York Stock Exchange (NYSE). They agreed to meet daily on Wall Street and buy and sell stocks.

By the mid-1800s the United States was experiencing rapid growth. Companies began to sell stock to raise money for the expansion necessary to meet the growing demand for their products and services. The people who bought this stock became part owners of the company and shared in the profits or loss of the company.

A new form of investing began to emerge when investors realized that they could sell their stock to others. This is where speculation began to influence an investor's decision to buy or sell and led the way to large fluctuations in stock prices.

Originally investing in the stock market was confined to the very wealthy. Now stock ownership has found it's way to all sectors of our society. 

What is a Stock?

A stock certificate is a piece of paper declaring that you own a piece of the company. Companies sell stock to finance expansion, hire people, advertise, etc. In general, the sale of stock help companies grow. The people who buy the stock share in the profits or losses of the company.

Trading of stock is generally driven by short term speculation about the company operations, products, services, etc. It is this speculation that influences an investor's decision to buy or sell and what prices are attractive.

The company raises money through the primary market. This is the Initial Public Offering (IPO). Thereafter the stock is traded in the secondary market (what we call the stock market) when individual investors or traders buy and sell the shares to each other. The company is not involved in any profit or loss from this secondary market.

Technology and the Internet have made the stock market available to the mainstream public. Computers have made investing in the stock market very easy. Market and company news is available almost anywhere in the world. The Internet has brought a vast new group of investors into the stock market and this group continues to grow each year. 

Bull Market - Bear Market

Anyone who has been following the stock market or watching TV news is probably familiar with the terms Bull Market and Bear Market. What do they mean?

A bull market is defined by steadily rising prices. The economy is thriving and companies are generally making a profit. Most investors feel that this trend will continue for some time. By contrast a bear market is one where prices are dropping. The economy is probably in a decline and many companies are experiencing difficulties. Now the investors are pessimistic about the future profitability of the stock market. Since investors' attitudes tend to drive their willingness to buy or sell these trends normally perpetuate themselves until significant outside events intervene to cause a reversal of opinion.

In a bull market the investor hopes to buy early and hold the stock until it has reached it's high. Obviously predicting the low and high is impossible. Since most investors are "bullish" they make more money in the rising bull market. They are willing to invest more money as the stock is rising and realize more profit.

Investing in a bear market incurs the greatest possibility of losses because the trend in downward and there is no end in sight. An investment strategy in this case might be short selling. Short selling is selling a stock that you don't own. You can make arrangements with your broker to do this. You will in effect be borrowing shares from your broker to sell in the hope of buying them back later when the price has dropped. 

You will profit from the difference in the two prices. Another strategy for a bear market would be buying defensive stocks. These are stocks like utility companies that are not affected by the market downturn or companies that sell their products during all economic conditions. 

Brokers

Traditionally investors bought and sold stock through large brokerage houses. They made a phone call to their broker who relayed their order to the exchange floor. These brokers also offered their services as stock advisors to people who knew very little about the market. These people relied on their broker to guide them and paid a hefty price in commissions and fees as a result. The advent of the Internet has led to a new class of brokerage houses. 

These firms provide on-line accounts where you may log in and buy and sell stocks from anywhere you can get an Internet connection. They usually don't offer any market advice and only provide order execution. The Internet investor can find some good deals as the members of this new breed of electronic brokerage houses compete for your business! 

Blue Chip Stocks

Large well established firms who have demonstrated good profitability and growth, dividend payout, and quality products and services are called blue chip stocks. They are usually the leaders of their industry, have been around for a long time, and are considered to be among the safest investments. Blue chip stocks are included in the Dow Jones Industrial Average, an index composed of thirty companies who are leaders in their industry groups. 

They are very popular among individual and institutional investors. Blue chip stocks attract investors who are interested in consistent dividends and growth as well as stability. They are rarely subject to the price volatility of other stocks and their share prices will normally be higher than other categories of stock. The downside of blue chips is that due to their stability they won't appreciate as rapidly as compared to smaller up-and-coming stocks. 

Penny Stocks

Penny Stocks are very low priced stocks and are very risky. They are usually issued by companies without a long term record of stability or profitability.

The appeal of penny stock is their low price. Though the odds are against it, if the company can get into a growth trend the share price can jump very rapidly. They are usually favored by the speculative investor. 

Income Stocks

Income Stocks are stock that normally pay higher than average dividends. They are well established companies like utilities or telephone companies. Income stocks are popular with the investor who wants to own the stock for a long time and collect the dividends and who is not so interested in a gain in share price. 

Value Stocks

Sometimes a company's earnings and growth potential indicate that it's share price should be higher than it is currently trading at. These stock are said to be Value Stocks. For the most part, the market and investors have ignored them. The investor who buys a value stock hopes that the market will soon realize what a bargain it is and begin to buy. This would drive up the share price. 

Defensive Stocks

Defensive Stocks are issued by companies in industries that have demonstrated good performance in bad markets. Food and utility companies are defensive stocks. 

Market Timing

One of the most well known market quotes is: "Buy Low - Sell High". To be consistently successful in the stock market one needs strategy, discipline, knowledge, and tools. We need to understand our strategy and stick with it. This will prevent us from being distracted by emotion, panic, or greed.

One of the most prominent investing strategies used by "investment pros" is Market Timing. This is the attempt to predict future prices from past market performance. Forecasting stock prices has been a problem for as long as people have been trading stocks. The time to buy or sell a stock is based on a number of economic indicators derived from company analysis, stock charts, and various complex mathematical and computer based algorithms.

One example of market timing signals are those available from http://www.stock4today.com. 

Risks

There are numerous risks involved in investing in the stock market. Knowing that these risks exist should be one of the things an investor is constantly aware of. The money you invest in the stock market is not guaranteed. For instance, you might buy a stock expecting a certain dividend or rate of share price increase. 

If the company experiences financial problems it may not live up to your dividend or price growth expectations. If the company goes out of business you will probably lose everything you invested in it. Due to the uncertainty of the outcome, you bear a certain amount of risk when you purchase a stock.

Stocks differ in the amount of risks they present. For instance, Internet stocks have demonstrated themselves to be much more risky than utility stocks.

One risk is the stocks reaction to news items about the company. Depending on how the investors interpret the new item, they may be influenced to buy or sell the stock. If enough of these investors begin to buy or sell at the same time it will cause the price to rise or fall.

One effective strategy to cope with risk is diversification. This means spreading out your investments over several stocks in different market sectors. Remember the saying: "Don't put all your eggs in the same basket".

As investors we need to find our "Risk Tolerance". Risk tolerance is our emotional and financial ability to ride out a decline in the market without panicking and selling at a loss. When we define that point we make sure not to extend our investments beyond it. 

Benefits

The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy. It's true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!

The Internet has make investing in the stock market a possibility for almost everybody. The wealth of online information, articles, and stock quotes gives the average person the same abilities that were once available to only stock brokers. No longer does the investor need to contact a broker for this information or to place orders to buy or sell.

We now have almost instant access to our accounts and the ability to place on-line orders in seconds. This new freedom has ushered in new masses of hopeful investors. Still this in not a random process of buying and selling stock. We need a strategy for selecting a suitable stock as well as timing to buy and sell in order to make a profit. 

Day Trading

Day Trading is the attempt to buy and sell stock over a very short period of time. The day trader hopes to cash in on the short term fluctuations in a stock's price. It would not be unusual for the day trader to buy and sell the same stock in a matter of a few minutes or to buy and sell the same stock several times a day.

Day traders sit in front of computer monitors all day looking for short term movement in a stock. They then attempt to get in on the movement before it reverses. The real day trader does not hold a stock overnight due to the risk of some event or news item triggering the stock to reverse direction. It takes intense concentration to monitor the minute by minute movement of several stocks.

Day trading involves a great deal of risk because of the uncertainty of the market behavior over the short term. The slightest economic or political news can cause a stock to fluctuate wildly and result in unexpected losses.

There are a few people who make respectable gains day trading. The people who probably make the most are the self proclaimed "experts" who sell the books or operate the web sites that cater to the day trader. Because of the profits to be made from sales to people who want to get rich quick, they make it seem as attractive as possible. The truth is that in the long run more people lose than gain by day trading. This does not translate into a very good investment.

Harry Hooper has over 30 years experience in portfolio management. He is the senior stock tracker for http://www.stock4today.com.

Key to Profitable Investing - Stock Market

The ebb and flow of stock markets present opportunities to profit if an investor understands these cycles. Since 1900 we have had 27 bull markets with corresponding bear markets to make things interesting. Presently, we are experiencing the 6th longest and the 5th weakest stock market rally as measured by the Dow.

While this is interesting, it would be more helpful if we could better understand these cycles in the market. Well, the stock market does tend to move in cycles, short term (also called cyclical), and long term (also called secular). Secular markets typically can last between 10 to 20 years, while cyclical markets usually last between 2 - 3 years on average. Think of a secular market as the primary long term trend, while a cyclical market is simply a shorter term cycle within the primary long term secular market.

As investors and traders, we need to understand where we are within these market cycles, so we can be on the right side of the trend to enhance our success. For example, the market was in a secular bull market from 1982 - 2000, experiencing a strong primary uptrend where the Dow Jones Industrial Average increased over 10 fold from about a low of 800 to over 10,000. Of course, there were short term bear markets such as in 1987, however, the easy money was made on the long side as the primary trend was up. 

However, here's where the danger lies: The majority of investors today have only experienced a secular bull market, such as the one from 1982 - 2000. Most of us have not experienced a long term secular bear market where the primary trend is mostly sideways to slightly down. The last secular bear market lasted 16 years from 1966 to 1982. Just to give you some perspective, the Dow Jones hit a high near 1000 in 1966, and hit a low in the 800s during 1982. In other words, the Dow essentially was flat for 16 years. During this time, the 'easy money' was not made on the long or short side, but by being being a good stock picker identifying undervalued opportunities, special situation stocks, and sectors that are temporarily strong. Understanding whether we are in a cyclical bull or bear market greatly enhances our chances for success.

The problem is that the secular bull market that began in 1982 ended in 2000. Therefore, while the stock brokers advice to hold for the long term was good advice for a secular bull market, it is totally the wrong strategy for a new secular bear market. The market entered into a new secular bear market in 2000, and as history shows, this new secular bear market will probably last at least until 2010 or longer. The market rally from early 2003 until now is simply a cyclical bull market within the new long term secular bear market. Holding for the long term will not work in this new secular bear market.

Let's look at each secular bull and bear market of the Dow over the last 100 years. As you can see, except for the secular bull market of 1921 - 1929, secular market cycles last on average 16 to 20 years.

- Secular Bull Market, 1982 - 2000, (18 years)

- Secular Bear Market, 1966 - 1982, (16 years)

- Secular Bull Market, 1949 - 1966, (17 years)

- Secular Bear Market, 1929 - 1949, (20 years)

- Secular Bull Market, 1921 - 1929, (8 years)

- Secular Bear Market, 1905 - 1921, (16 years)

Secular Bull Market, 1982 - 2000 (18 years)

Let's work backwards, beginning with the last secular bull market, which lasted from 1982 - 2000. The Dow increased over 10 fold from a low of about 800 to a high in the 11,000s. The strong primary trend was up and the best way to make money was to be long in your positions. Only the nimble were able to take advantage of the few cyclical bear markets that occurred in 1987, 1991, and 1998. These pull backs were also opportunities to establish new long positions.

Secular Bear Market, 1966 - 1982 (16 years)

Prior to the last secular bull market, the market was in a long term secular bear market which lasted from 1966 to 1982. During this time, the market essentially went sideways for 16 years. For example, the Dow hit a high of about 1000 in 1966, and low in the 800s in 1982. If you would have followed your brokers advice to 'hold for the long term' you would have been greatly disappointed. Sixteen years is a long time to receive next to nothing in return on your money.

The chart of the Dow below from 1966 to 1982 is a classic example of what a secular bear market looks like. There were strong cynical bull and bear markets during this time that caused the market to essentially remain flat for 16 years. However, there were shorter term cyclical bull and bear markets that could be traded.

If you could use a time machine and jump forward 10 years from now, I think this how a chart of the Dow or NASDAQ might look. Both traders and investors will need to do their homework, seeking sectors and stocks that present great value opportunities.

Secular Bull Market, 1949 - 1966 (17 years)

The Dow was in a secular bull market from 1949 - 1966. Here the primary trend was up, which is typical for secular bull markets. The easy money was made by primarily remaining long throughout the cycle.

Secular Bear Market, 1929 - 1949 (20 years)

From 1929 until 1949, the Dow was in the famous secular bear market which also defined the Great Depression. After the nightmare crash from 1929 to 1932, the Dow essentially went sideways to slightly up for the next 17 years, but did not reach its old highs near 375 until the early 1950s. However, there were cyclical bull and bear markets during this long term secular bear market.

The Dow experienced the mother of all crashed from 1929 until 1932. Then from 1932 until 1937, the Dow nearly quadrupled from a low of about 50 to 200. Then from 1937 to 1942 the DOW lost about half of its value from near 200 to about 100 (cyclical bear). Then from 1942 to 1949 the DOW recovered (cyclical bull).

Secular Bull Market, 1921 - 1929 (8 years)

From 1921 until 1929, the Dow was in a strong secular bull market. Actually, from a chart perspective this period was very similar to the more recent 1982 to 2000 secular bull market. The primary trend was up, and the easy money was made by buying and holding for the long term.

Secular Bull Market, 1905 - 1921 (16 years)

The Dow was in a secular bear market from 1905 until 1921. This secular bear market was typical of most secular bear markets, such as the one from 1966 - 1982, composed of mostly vicious cyclical bull and bear markets that result in a mostly sideways long term movement.

Hopefully, you realize it is very important to know the market's primary secular and cyclical trend. During secular bull markets, the easy money is make by staying long. However, during secular bear markets, staying long produces poor results at best and you could lose a lot of money. Stock picking and following the hot sectors is important for success.

Conclusion

The current market entered a long term secular bear market in 2000, and as history shows us, this will last at least until 2010, probably longer. As discussed above, during secular bear markets, the market trades in vicious cyclical bull and bear markets. Therefore, you have to be careful in the stocks you buy and be ready to sell them quickly should the market turn against you. Pull backs or cyclical bear markets will present opportunities to take new positions once they have run their course. It is also important to find value situations and play the hot sectors. You need to be defensive in our positions and for those who are willing to take the risk, you may want to take some short positions.

Trading and investing is much easier in secular bull markets, and much more difficult during secular bear markets. Since we are in a secular bear market for the next 5 to 10 years, it is going to be much more difficult to be successful in your trading and investing.

Currently, the cyclical bull market that begin in early 2003 is close to being over and a new cyclical bear market will begun that will last another 2 to 3 years. This means that the best plays will be on the bearish side for the next couple years, that is, until the next cyclical bull begins.

Hans Wagner runs a web site focused on stock market strategies and model portfolios for the investor and trader at: http://www.tradingonlinemarkets.com