Prosper Newsletter: February 2008 > Stock
You understand that the following information is educational in nature and is not intended to be legal, accounting, or tax advice. You are responsible for your own financial decisions and should consult your own legal, accounting, and tax advisors before making your financial decisions.
The market is going down. What should I do?
Timing the market is difficult—even for the experts. The average investor doesn't have the resources that fund-managing professionals have to offset losses and hedge against downturns. However, you can protect your portfolio against downturns through various strategies.
For example, diversification it one such strategy. The Perfect Pie approach (1/3 stocks, 1/3 bonds, 1/3 real estate) is often a great strategy for staying diversified. With the right asset allocation, you can keep your investments safe. Those who diversify during market downturns are not likely to lose as much as those who throw all of their money into one or two investments. Sometimes, you can even realize profits in a bad market if you have a good blend of stock funds and bond funds.
One bad thing that many investors do during market downturns is sell parts or all of their portfolios. This is the absolute worst thing an investor can do. Why? Because once the market has taken a dip, the damage is already done. By cashing out, the investor misses out on the inevitable rebound or risks missing out on the best trading days of the year! Even worse is when panicky investors pull cash from a tax-deferred portfolio. Not only do they lose money from the downturn and risk missing out on rallying days, but they also lose most of the benefit they had from their employer-matched funds. The penalties and taxes they end up paying will likely offset any of those gains.
Just like with real estate, it's not so much about timing the market as it is about time spent in the market. Never miss the best days. After a dip, there's always a rebound. You don't know when that day will be. If you don't get your money in the market on those rallying days, you'll miss out on the best earnings.
A better strategy is to buy more when the market is down. Try another back-to-basics strategy of putting more money into savings and investment accounts. For example, because the market is down, the prices on great blue chips are often artificially low. With bargains out there for the taking, why wouldn't you invest more? When the market starts climbing again, your gains will potentially be exponentially more.
Don't be afraid of the financial rollercoaster. Take heart that the economy has corrections, dips, rebounds, rallies, and bubbles. That's the nature of the market. Get back to the basics and stick with what works.
A whole new world of information and excitement!
Life prior to entering the coaching program was working hard at our respective jobs and just getting by, but not satisfied. Coming into this experience our knowledge of stocks and the market was very limited. We had no comprehension of indicators, or how to maneuver around the web with the vast information available to the novice. Now, after four months, we have been exposed to a whole new world of information and excitement! Goals set for ourselves are to be financially solvent and independent of other employment. These are not necessarily ‘new' goals for us since the start of the program, but with renewed interest due to completion of this coaching program.
Through the mistakes we made through paper trading, and the weekly reviews, we have gained some insight into the genre of the ‘Stock Market Success System'.
Phillip B. & Teresa M.
Getting Back to the Basics
In the last few months, we have seen tremendous volatility in the stock market. We have also heard talk of recession and a bear market. The S&P 500 shows signs that the market will take a downturn. It's times like these when investors must re-evaluate their current trading strategies and decide which direction to play the market. It is also a time to get back to the basics of investing, which means performing proper fundamental and technical analysis.
A fundamentally strong company will tend to go down the least in a bear market and go up the most in a bull market. A proper fundamental analysis will show the strength of a company through a few key areas within a company. These areas include the following:
- Average Daily Volume. Higher volume will increase liquidity and should have more price movement. (Look for volumes greater than one million.)
- Institutional Ownership. A high percentage of institutional ownership is a good sign.
- Price/Earnings (P/E) Ratio. Ideally, a company's P/E ratio should be below 20. A high P/E may mean the stock is overvalued and could correct itself. You may still find great companies with high P/E ratios. For example, if a company's products are in high demand, you can sometimes ignore a high P/E. Also, always read the recent news and check for any bad news from the past.
- Earnings Estimates. This is one of the last areas to look at and one of the most important. Look for a number above 20% for the next few quarters (or for an average above 20%).
Note: Keep in mind that these numbers are guidelines, not absolutes. Remember this phrase as you perform a fundamental analysis: "If it's close it's better than most".
A Technical analysis is another must for getting back to the basics. Watch the RSI, MACD, and the Slow Stochastic indicators. Also, watch the volume. Be patient for just the right time to enter and exit a trade. Typically, along with the indicators pointing the same way, you like to see the volume levels 100% higher than normal. Much higher volume levels will push the stock up (or down) and keep it at those new levels.
Once you execute a trade, protect your profits! If you have a profit and the indicators start looking weak, you may want to exit the trade and take the profit while you still have it. Remember, the trend is your friend. Examine the stock's and market's trend and trade with the trend and not against it. For example, if a stock is in a downtrend, you should buy puts, not calls.
These are some of the most important criteria when trading stocks or options. Many new investors go through a losing period and decide that they have drifted away from the basics. Once they realize what they have done, they often return to the basics. Consequently, their investing once again becomes consistent. Take the time to get back to the basics. Happy trading.
