More Stock Investment Strategies

There are a tremendous number of stock-buying strategies. Many of them are based on the basic fundamental- and technical analysis methods expounded upon in the article Basic Investment Strategies. While it would be impossible to cover them all, here are some of the most popular approaches used by experienced investors. Many of these strategies can be combined with others to formulate a more personalized technique that will meet your individual needs, based on your own investment philosophy. But no matter what strategy you choose to make use of, the ultimate key to success lies in staying true to those investment ground rules that you designate for yourself.

Value investing is one example of how an investment approach uses fundamental analysis. It involves purchasing stocks that are considered undervalued by one or more fundamental measures. Although this may sound simple, determining the criteria for an undervalued stock is something that is not widely agreed upon among investors.

Formerly, a stock was considered undervalued when it was being traded at less than the sum of its total assets; or in other words, below its book value. However, few investors continue to use this definition. Instead, more modern valuation theories state that intangibles such as intellectual capital (or, an intelligent and viable work force) are of great importance to a company's overall worth. Advocates of this type of thinking tend to use other valuation methods, such as the price-to-earnings (P/E) ratio, to determine whether a company is undervalued.

Growth investing has often been considered the direct opposite of value investing because growth investors focus on how quickly a company has been growing, rather than on how closely its share price reflects its current value. Measuring a company's growth usually involves determining how quickly it has been increasing its earnings or revenues. However, successful growth investors not only look for those companies that have the fastest growth rates, they look for companies that are experiencing this growth at a reasonable price.

The main risk with investing in growth companies is that their growth rate may decline in the future; therefore, it's wise to consider companies that have long histories of strong performance. In general, growth investing tends to be somewhat riskier than value investing, but the potential gains are likely to be greater as well.

The buy what you know approach is actually a way of finding potential investments rather than a pure investment strategy. It involves investing in companies that you or others that you know do business with. As an example, let's say that you decide to try out a new department store in your area. Upon arrival you find it very difficult to find a parking space because the lot is completely full. Inside the store, you notice that the prices are very reasonable and the checkout lines are packed with shoppers. So you decide to do a little informational digging into the company. If what you find out seems to be good, and the company is publicly traded, you might decide to purchase its stock.

Another example of buying what you know would be purchasing stocks of companies that operate within your area of expertise. For instance, if you're interested in cars, you may be adept at picking good auto stocks. But it must be remembered that you must keep your portfolio diversified to ensure that all of your stock holdings aren't too closely related to your area of interest or occupation.

Market timers try to anticipate price movements and aggressively buy and sell based on those predictions. Most investors using this approach employ technical analysis as their method of predicting the movements – although it's possible to use other means, such as daily movements or multiyear cycles. Some are very successful at it; nevertheless, market timing is extremely difficult.

Becoming popular in the 1990s, day trading is closely related to market timing. It involves the rapid buying and selling of stocks, with all activity usually occurring within a single day. The rationale that drives this technique is that since stocks move up and down throughout the day, it should be possible to buy a security, wait for a small move upward, and then sell it. But it's far from easy, and the commissions and taxes that are normally involved with buying and selling stocks make it even more difficult to consistently earn a profit.

The Dogs of the Dow, as the Dow dividend strategy is called, is a fairly straightforward way to invest in stocks. It works in this manner: at the end of every year, you buy the ten highest-yielding stocks from the list of 30 that comprise the Dow Jones Industrial Average, putting the same amount of money into each one. You then hold these ten stocks until the next year, at which point you repeat the process, keeping those that remain in the top-ten list and selling those that drop out. With the proceeds, you purchase the newcomers to the top ten. Historically, this strategy has worked well – even during periods of overall market weakness – because over the long term stocks have tended to increase in value.

Dollar cost averaging is arguably one of the safest and most powerful methods of investing in use today. It involves investing a fixed amount of money into the same stock (or group of stocks) on a regular, ongoing basis. The rationale behind dollar cost averaging is that you establish a position in a stock over a long period of time. During that time, the stock's price will likely fluctuate, but by investing a set amount every month, you actually benefit from the periods of weakness. This occurs because for the same amount of money, you can buy more shares when the price is lower. As long as the stock's price increases over the long haul, you'll do well. Another significant advantage of this approach is that once you set it up, it automatically forces you to continually contribute into your investment plan.

Using a method called bottom fishing, investors look for stocks that have been badly beaten down, usually through a sudden and sharp drop in price. Such investors may actually be value investors searching for stocks that have fallen to attractive prices. In other cases, they may simply be investors buying the stock in anticipation of a short-lived price rally that often occurs after a steep sell-off. Regardless of the reason, however, bottom fishing is somewhat risky because there's usually a cause behind a stock's dramatic fall. The prudent investor will attempt to determine what that basis is and if it seems temporary or more long-term.

Some shareholders reinvest the dividends they receive into the companies that pay them out. This can be quite profitable due to the effect of compounding interest. Additionally, using this method, all of the components of the investment – the stock's price, the number of shares held, and sometimes even the dividend itself – tend to increase over time. Needless to say, the longer that this strategy is followed the greater the effect it's likely to have. And because dividends are paid on a regular basis, reinvesting them also serves as a form of dollar cost averaging.

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