In order to trade the stock market, there are two basic ways - shooting in the barrel or using strategies to find out which stocks to buy,
when to sell, and how to protect your investment dollars. Strategies do better
than barrel shooting by a large margin.
The beginning investor is advised to investigate some of the
basic strategies and see for himself how they perform.
Stock Trading Strategies: Hedging
Hedging is a way of protecting an investment by reducing the
risks involved in holding a particular stock.
Within a certain frame, the risk
that the price of the stock will drop can be make up for buying a put option
that allows you to sell at the stock at a precise price. If the price of the
stock falls, the value of the put option will increase.
The most expensive hedging strategy is buying put options
against individual stocks. Buying a put option on the stock market itself is a better
option if you have a broad portfolio.
This protects you against general market
declines. Selling financial futures like the S&P 500 futures is another way
to hedge against market declines.
Stock Trading Strategies: Dogs of the Dow
During the 1990s, this is a strategy that became popular. By
choosing the 10 stocks that have the lowest P/E ratios and the highest dividend
yields, the idea is to buy the best-value stocks in the Dow Industrial Average.
The companies on the Dow Index are mature companies that offer consistent
investment performance. The idea is that, over the coming year, the lowest 10 on the
Dow have the most potential for growth. A new twist on the Dogs of the Dow is
the Pigs of the Dow.
By looking at the percentage of price decline in the
previous year, this strategy selects the worst 5 Dow stocks. As with the Dogs,
the idea is that the Pigs stand to rebound more than the others.
Stock Trading Strategies: Buying on Margin
Buying on margin means to buy stocks with borrowed money - typically
from your broker. Margin gives you more return than if you were to pay the full
cost outright since for a lower initial investment, you receive more stock.
Margin buying can also be unsafe since if the stock loses
value your losses will be equally greater.
When buying on margin the investor
should have stop-loss orders prepared to limit losses in the case of market
reversal. The margin amount should be limited to about 10% of the value of your
total account.
Stock Trading Strategies: Dollar Cost and Value Averaging
Dollar cost averaging involves investing a fixed dollar
amount on a habitual basis. An example would be buying shares of a mutual fund
on a monthly basis.
The investor will receive more shares for his money if the
fund drops in price. On the other hand, the fixed amount will buy fewer shares when
the price is higher. An alternative to this is value averaging.
The investor makes a decision on a regular value he wishes
to invest. For example, he may wish to invest $100 a month in a mutual fund. The
investor puts a higher amount in the fund when the price of the fund is high
and he spends less money when the price is low.
This averages out his
investment to the original $100 per month. As a percentage return on the money
invested, value averaging almost always outperforms dollar cost averaging. It
can help secure the growth of your investment fund when used as part of a
broader trading strategy.
Related Articles:
|
