Stock markets are quite unpredictable. Any trader, no matter how experienced, can be easily caught off guard if not careful.
As every trader knows, the key to profiting from the market is – buy low, sell high. However, the challenge that every trader faces is finding the lowest low and the highest high – an activity that’s easier said than done. Practising a sound money management strategy may help to mitigate the situation.
Consider buying over a period of time.
Investment guru Warren Buffett said at the Berkshire Hathaway Annual Meeting in 2004, “If you invested in a very low cost index fund – where you don’t put the money in at one time, but average in over 10 years – you’ll do better than 90% of people who start investing at the same time.”
Averaging is a common money management strategy used.
How does averaging work out in the long run?
In an article on cost averaging that appeared on Share Market School, it was mentioned that dollar cost averaging should be carried out on a business that’s fundamentally strong instead of a hot stock. What does this mean?
Stocks that may be the flavor of the moment for no apparent reason other than speculative interest may not be a good idea for averaging to be carried out effectively. Your effort in trying to average out the price may end up futile at the end of the day. On the other hand, averaging on a business that is fundamentally strong is a much wiser option.
When choosing to invest in a business, one would have done the homework, researching to ensure that the nature of business holds potential with a strong management team in place and backed by solid financials.
Blue-chip companies normally fall under this category. Buying shares in such a company requires a lot of money as their shares are premium priced. Thus, it may be easier on the trader’s pocket as well to buy in bite sizes rather than huge chunks. As Mary Kay Ash, the late founder of American cosmetics giant Mary Kay Cosmetics put it aptly, “You can eat an elephant one bite at a time.”
Imagine buying a RM20/share company. If a trader were to buy 1000 shares at one go, RM20,000 would need to be paid. However, if one were to break it up into 10 smaller parts of 100 shares per purchase, it only costs RM2000 each time.*
*Calculation above does not include commission/brokerage charges.
Before choosing to invest in a company, do your research in a company to ensure that it is a valid choice. Make sure that the share price of the company is worthy of the fundamentals.
Watch out for uncommon activity such as sudden interest or sudden massive selling. Investigate the reasons behind the blips on the radar.
Averaging works best for companies that are fundamentally sound. Their prices fluctuate because of market conditions. Thus, if the stock of a company with good potential is under pressure, experts say that there is high chance that averaging will work.
Consider the following three factors when identifying a fundamentally strong company:
- Strong balance sheet;low debt and high cash reserve
- Good management
- Solid unique selling proposition
If prices of the stocks that you are interested in seem prohibitive, don’t worry. Take it one step at a time.
Do your Research
27/06/2013 · by RHB Investment
