Alpine Summit

Wednesday, August 03, 2005

Investment Crash Course, Part 3

Alright, so from my previous two posts, you should have a vague idea of how the stock market works, and how investors exploit the market to make a profit. This post will go over some of the tools available to investors that help them choose the best strategy. This is where investing gets VERY opinionated and I guess you could call it the realm of the "experts." Anyway, let's get into it, shall we?

First of all, there are two types of stock analyses; fundamental and technical.

Fundamental analysis looks at the balance sheets and income statements of a company as well as what products the company is planning to debut; known as what's in the pipeline. It also looks at potential market share, competitors, comparisons with substitute products, price to earnings ratio, etc. etc. Fundamental analysis simply (or not-so simply) looks at all the business factors associated with a company. The idea is that if a company is doing things that will raise its stock's book value, people will want that stock and will naturally raise the public demand for that stock as well. One man took an investor's tour of Enron before it went out of business and by examining its financial statements and touring the facilities, decided to sell several thousands of shares of the stock short at about $60/share. People thought he was crazy but he had the last laugh. He bought the shares back at about $0.50/share or so. He was investigated, but they found he wasn't involved with the corruption. By performing "due diligence," that is researching the stock completely before making a decision, he could see that the company wasn't doing well.

The other type of analysis is called technical analysis. This deals with looking at chart characteristics of the stock... actually looking at the chart, and determining whether or not the stock will go up or down based on that. I equate this type of analysis to financial voodoo because this analysis neglects all the business factors of the company and the book value of the stock. It cares more about historical data to predict the future. Some chart characteristics are actually pretty accurate sometimes. Exhaustion gaps are a good example of this. Actually, is a great place to learn about technical analysis. I try to stay away from it though- it takes too much faith for me to put total confidence in it. Charts are good to get historical data on a stock, but I don't think it's good to make a stock purchase based solely on technicals. My own opinion is that the spotty accuracy of technical analysis, coupled with the due diligence of fundamentals, is the best route to take.

Charts can be useful, but if you're buying a stock simply because there's a double bottom reversal is stupid. My advice: don't put too much confidence in technicals. You'll do much better by sticking to fundamentals.

Hopefully these posts give you a good jumping-off point to start researching stocks yourself. The cool thing about the stock market is you can play around with pretend money before actually investing in anything. Just assume you have a broker and all that and see how your stock picks will do and keep a tally of your wins/losses before actually investing money in anything. You can learn a lot by doing this and can see if you have "the touch."

One last thing I guess I should talk about are brokers. You MUST have a broker in order to invest; unless you have thousands of dollars to buy rights to walk the floor yourself. I use Scottrade as my broker. They have $7/trade meaning a round trip (buying then selling) on a stock will cost me $14. There are other online brokers such as Ameritrade, Charles Schwab, Fidelity, and TD Waterhouse to name a few. Shop around for the one you think best suits you. You can always go with one of the more traditional $200/trade brokers, but things are fairly hands-off and really designed for people who can afford to pay $200 just to buy or sell a stock. Most people would consider this outside of their price range. Plus they get to do all the fun stuff! I liked Scottrade because they seemed to have the best value even though they aren't the cheapest.

Oh, and should you decide to go with Scottrade and would like to show your appreciation for my writing this, please contact me and let me refer you- I get free trades for referals. Also, let me know if there are some other general items you would like me to talk about and I'll make subsequent postings on it.