Many words have been written on the topic of how to make money in stocks. Most of these articles and advice actually do tremendous disservice to you as a long term investor.
But there is something that works if you want to make money with stocks. It is simple to understand, because the idea behind this method just makes sense. This is also how some of the richest investors got so wealthy. If you are looking for stocks to make quick money, this guide may not be of much assistance.
Building serious wealth takes patience, discipline and time.
But if you are looking for how to make money with stocks long term, you will find very useful information here.
3 Different Ways of Making Money in Stocks
There are many different ways of investing. We can do it based on styles, or we can do it based on methods used (or not used). Each of the 3 ways listed here has its own set of strategies. Some work and most do not work, but people try any how because they promise a lot and very quickly.
I will define speculation as trying to invest without knowing how and why you are picking a stock.
Has this every happened to you? You get a hot tip from a friend, or the shoe shine boy, or your barber. The arguments are very passionate and it convinces you with the infallible logic of dancing $ signs in front of your rose tinted glasses. So you “invest”.
Afterall, if even your barber knows about this stock, then it must be really good.
Maybe the scenario was more like the one in the “Wolf of the Wall Street”. It is the voice at the other end of the phone line who does the convincing. The voice is suave, persistent and pushes all the right buttons.
Regardless of how it happens, you end up buying a stock that is the flavor of the day. You feel good as you see other gullible investors pile in and your portfolio grows greener and greener. Then tomorrow, the flavor of the day changes and the red ink is all over your portfolio.
We think this will never happen to us. However, in reality, MAJORITY of the investors invest with NO strategy at all. Their idea of picking stocks is by talking to someone they think knows what they are doing, and/or, listening to the sound bites on TV. The problem is that the other people are doing the same, and the TV just reports what most investors are doing. This is the classic definition of the herd mentality.
Still don’t think this can happen to you?
Humans have always made decisions based on emotions, specially when it comes to money. There is a point where rational thought gets superseded by greed.
We have had the old bubbles and subsequent bust in
And of course the more recent internet and real estate bubbles. I was investing during the time when the internet bubble burst, and also during the time when the real estate bubble burst, and I have seen extraordinarily smart people lose significantly in the market.
All because they got carried away with the prevailing entiment of euphoria and did not feel it necessary to understand what they were investing in.
Any time your investment strategy is “everyone else is doing it”, it is speculation, and it will hurt you.
2. Technical Analysis
Also sometimes called behavioral investing, technical analysis has worked for many investors. The practice has its underpinnings based upon solid psychological research and attempts to model the speculative tendencies of the crowds I described above.
New investors take note: If you do not know what you are doing, rest assured that there are many smart people in the market that have modeled your behavior to figure out most efficient ways to part you with your money.
In practice, this seems harmless enough. Some geeks consulting esoteric charts to predict the next move of the stock, or the index in question. Whether a trade will be profitable or not is determined by what they expect the herd to do based on what they have done in the past.
It is pure psychology. It doesn’t always work because the markets are influenced by more things than just investor behavior in the long run. In the short run though, the results can be very satisfying, even if inconsistent over time.
Reminiscences of a Stock Operator tells the story of Jesse Livermore, arguably the best technical trader in history. He made and lost his fortune a number of times.
3. Fundamental Investing
Fundamental investing is any process that allows an investment decision to be made based upon the realities of the underlying business. In the simplest sense, if the business (or company) does well, the stock price will do well.
How do you make money from stocks using fundamental investing?
Pay heed to these 4 words that all investors need to live by: Buy Low, Sell High.
If you are a net buyer, your profits are equal to the selling price – the buying price.
If the selling price is higher than the buying price, you have positive profits. Otherwise you lost money.
The question than becomes, how do you figure out what is a low price and what is a high price for any given stock?
Before we try to answer this question, I want to point out that fundamental investing tries to create a framework of investing where logic and rationality can come into play.
It is neither a successful strategy nor a failed strategy. The success and failure lies solely upon you as an investor. How good are your logic skills, how well do you understand the business, and finally, how objective you remain during the entire investment cycle.
You can undo all the good work done in selecting a stock by later giving into emotion and make wrong choices.
How do you make money in the stock market? By making less mistakes.
If you invest randomly in the stock market, you will make money in the long term. Most people do not invest randomly. They let their biases and outside influences dictate their investment decisions, and that hurts their investment returns.
Two Ways of Finding Low Price and High Price
I will make an assetion here that many will find controversial as we are constantly fed the diet of Value vs Growth.
All investing is value investing
In both growth investing and value investing strategies, investors believe that the current stock price is below the current value of the stock.
In growth investing, the majority of the current value of the stock is in the form of the future earnings growth.
In value investing, the majority of the current value of the stock is estimated by looking at the current asset and operations of the company.
Growth investors believe that the future growth of the company will create significant value for the shareholders, and that justifies paying up now.
Value investors believe that the value already exists in the company, and in the future the rest of the market will also realize this and adjust the stock price to reflect this value.
Growth investing places a faith in the future growth to actually materialize and create the value as expected.
Value investing places a faith in the market eventually figuring out their mistake.
So they may be both based on certain judgements, but they can both make money for the investors based on mostly sound logic and actual business fundamentals.
The very best way to make money in the stock market for the long term?
Value investing has been shown in the historical studies to outperform growth consistently. A few studies are referenced here.
Today we are sitting in the time when Value investing is again getting renewed interest after many years of growth dominance. This makes this a very exciting time to buy value stocks.