Making Money Slowly

A strategy is a plan that helps you determine what stocks to buy or sell. If you are new to the stock market, it's best to keep an open mind before choosing a strategy. If a particular strategy seems to make sense to you, take the time to do more research. It can take a long time before you find an investment strategy that not only makes sense but also increases the value of your portfolio. Keep in mind that you aren't limited to only one strategy. Some investors and traders use a variety of strategies, whereas others are comfortable using only one. No matter what strategy you use, here are a few things you should remember:

• A strategy is only as good as the person using it. In other words, no matter how brilliant and ingenious the strategy, you can still lose money.
• Not all strategies work during all market conditions.
• Don't become so devoted to a strategy that you are blind to the fact that you are losing money. Money is the scorecard that determines whether your strategy is working.

You have to take the time to find the strategy or strategies that fit your personality and lifestyle. Unfortunately, there are no magic answers to finding success in the stock market. For most people, the only way to find out what ultimately works on Wall Street is through trial and error.

Buy and hold

The reasoning behind the buy-and-hold strategy is that if you buy a stock in a fundamentally sound company and hold it for the long term (at least a year), you'll realize a profit. The beauty of a buy-and-hold strategy is that you can buy a stock and watch it rise in price without having to constantly watch the market. Investors who bought companies like IBM, GE, and Microsoft in the early days made huge sums of money on paper without having to pay much attention to the market. The other advantage of buy and hold is that because you are not constantly buying and selling stocks, you are paying very little in brokers' commissions. Buy and hold is the easiest investment strategy to use, and, in retrospect, it worked extremely well during the bull market of the 1990s.

Perhaps the only time buy-and-hold investors sell is if something fundamentally changes in a company. They don't sell because of what is happening to the market, the economy, or the stock price. They are focused only on the business, and they intend to hold their reasonably priced stocks as long as possible.

One of the most successful buy-and-hold investors of the twentieth century is billionaire Warren Buffett. He rarely buys stocks in technology companies, but rather buys the stocks of mundane companies such as insurance companies and banks, and he has the skill (along with a team of independent analysts) to buy low and sell high.

In the hands of a professional, buy and hold can work, although many investors who used this strategy ended up losing their shirts during the recent bear market. Rather than buying low-priced value stocks, they bought and held high-priced technology stocks. Buy and hold does work, but it's not as easy to use as people think.

Buy on the dip

The buy-on-the-dip strategy was also very popular during the 1990s. In this strategy, when a stock you like goes down in price, especially if you believe the decline is only temporary, you buy more shares. The idea is that because the market always goes up over time (or generally has in the past), the shares you bought at a lower price will eventually be worth more. People who used this strategy in the past made tons of money as the shares they bought kept going higher.

The problem with buying on the dip is that stocks sometimes dip two or three times before dropping permanently. In the late 1990s, millions of people poured their life savings into stocks that seemed like bargains but actually were extremely overpriced. With every dip, more buyers stepped in. Then, during the 2000 bear market, many of these stocks didn't just make a temporary dip, they crashed. During the bear market, the stocks that made up the Nasdaq fell by over 80 percent. It is still too early to know if these stocks will ever return to the price levels they were at before.

Bottom fishing

If you are a bottom fisher, you look for stocks that are so low that they seem to have hit bottom. Professional bottom fishers are constantly on the lookout for stocks that are so low that they have nowhere to go but up.

The danger of bottom fishing is that you never know exactly when the bottom has been reached. For example, when Enron went from nearly $100 a share to $15, many people bought more shares, assuming that the stock couldn't go much lower. When the stock was trading at $1 a share, the bottom fishers stepped in. The stock then fell almost 94 per-cent before really hitting bottom, finally closing at 6 cents. You also face the danger that companies like Enron will eventually go out of business.

Because it could be years before many of these unloved stocks rise in price, you have to be extremely patient to be a successful bottom fisher. Stocks that are in the basement tend to stay there a while. (Many bottom fishers will wait 2 or 3 years before scooping up favorite stocks that other investors have ignored.)

A systematic stock-buying approach

Instead of buying stocks whenever you have extra money in your pocket, with dollar-cost averaging you buy stocks on a regular, systematic basis. You invest a set amount of money, perhaps $100, each set period of time-for example, each month. The beauty of this system is that as you buy stocks that are dropping in price, your average price per share also drops.

For example, let's say you buy 100 shares of Bright Light at $20. The next month it drops to $10, so you buy another 200 shares. Your average cost is now $13.33 a share. As long as the market keeps bouncing back, dollar-cost averaging is a winning strategy. The problem is that if your stocks keep dropping, you will be left with substantial losses.

A strategy similar to dollar-cost averaging is called averaging down. With this strategy, instead of investing a set amount of money each set period, you buy additional shares of stock on the way down. With dollar-cost averaging, you have a plan. With averaging down, you buy additional shares of stock whenever you please.

Value investing

Value investors primarily use fundamental analysis to pick good-quality stocks that are a bargain compared with their actual worth. In other words, value investors are looking for stocks that are on sale. Often, value investors will buy stocks in companies that other investors don't want. These are the low-P/E stocks of companies whose earnings grow slowly, such as insurance companies and banks. Value investors are long-term investors and are willing to wait years for their stocks to become profitable.

During the 1990s, value investors were ridiculed for not buying the high-flying technology stocks. While some growth stocks were doubling or tripling in price, many value stocks were producing what some considered pitiful returns. Ironically, after the 1990s ended, value stocks were back in favor. It seemed as though everyone wanted to buy fairly valued stocks in companies run by competent and honest managers that showed signs of improved earnings performance.

Buying growing companies

In general, growth investors use fundamental analysis to find stocks that are growing faster than the economy or earning more than other stocks in the same industry. Growth investors like to see earnings growing by at least 15 or 20 percent a year for the next 3 or 4 years. Most important, these companies' earnings are growing faster than those of other companies in competitive industries. Usually, these stocks don't pay dividends because whatever extra money the company earns is plowed back into the company.

For many years, growth investing worked spectacularly well. lnvesting in growth stocks, particularly technology and Internet companies, was all the rage during the 1990s. It was not uncommon for investors to see returns of 100 percent or more per year. Although investing in growth stocks can be risky, the rewards can be tremendous.

An offshoot of growth investing is called growth at a reasonable price (GARP). Investors who engage in this strategy basically combine value and growth investing into one strategy. They are looking for growth stocks, but they are willing to wait until they can get the stocks at a reasonable price.

Buy high and sell higher

Momentum investors are growth investors who look for stocks that are ready to make explosive moves upward. They buy stocks at a high price but plan to sell them at an even higher price. They don't care too much about the price they paid as long as the stock goes higher. Momentum investing works best during bull markets when there is a lot of liquidity. In the late 1990s, it seemed as if no matter which stock you bought-especially if was an Internet stock-the stock would go higher.

Some critics call momentum investing the "greater fool theory," which means that no matter how high the stock price is, you will always be able to find a bigger fool who is willing to buy it from you. Momentum investors tend to use technical analysis to look for stocks that will make sudden and dramatic moves in a short period.

In the go-go 1990s, a surprise announcement or positive rumor could send stocks up 20 or 30 points in one day. Although it is still possible to find momentum stocks, it's not as easy as it was a few years ago.

Momentum investing, although exciting and potentially profitable, is a difficult strategy. Many momentum stocks can explode in either direction, often costing you a lot of money. Although it's possible to catch some of these stocks on the upside, it is definitely not as easy as it looks.

Contrarian investing

Contrarians, as they call themselves, use fundamental analysis to find high-quality companies with low P/Es that other investors have abandoned. The more unloved the stock, the more contrarian investors like it. When everyone else was accumulating technology stocks in the late 1990s, contrarians were buying out-of-favor companies like Waste Management (WMI) and Red Hat (RHAT). After many technology stocks imploded, contrarians were scooping up shares of stock in unloved companies like Xerox (XRX).

Contrarians are especially fascinated by a company that the media and other investors hate. However, it takes a tremendous amount of skill and patience to find formerly high-flying stocks that will once again outperform the market. In addition, it takes courage to buy stocks that no one else wants.

There is also a group of contrarian traders called "investolators" who use technical analysis, especially charts and institutional owner-ship, to find stock picks. Just like contrarian investors, investolators look for unloved companies that have hit bottom. Ted Warren coined the term investolator in the 1930s, combining the words investor and speculator.

Back To Top