Shorting Stocks

12

Shorting Stocks

from ClearStation.com

When you make a decision to act upon a stock, you are taking a position.

There are two kinds of positions you can take—a long or a short position. Taking a long position means buying the stock based on the belief that the price will rise. A buyer would take a long—or bullish—position.

The short position is a little more complicated. The idea behind shorting is that you sell the stocks and then buy them when the price falls, earning you a profit. Sounds odd, doesn't it? Here is how it works:

You decide that the price of a certain stock is going to fall. You call your broker and put in an order to short, "selling" the stocks at the current price.

Your broker rounds up the shares in order to sell them for you—he either loans you the certificates from his stash, from the account of

one of his other clients, or borrows them from another broker. Then, when the price falls, you buy the shares at the lower price, covering the number of shares that were borrowed.

Investing in Penny Stocks

11

Investing in Penny Stocks

from Investorama.com

 

Does this sound like a bargain to you? You discover that shares of Fabulous New Products, Inc., are selling for just 32 cents per share. You try to do a little research to find out more about this company, but there's not much available on the Internet. So you go ahead and buy 2000 shares, at a cost of $640 plus commission. How much could you lose, you figure?

Well, you could lose $640, that's how much! And in the world of "penny stocks," chances are good that you will lose out on your investment! Penny stocks are those companies whose share prices are below a dollar. While many investors are attracted to them because of their low prices, they are actually some of the riskiest investments you can purchase.

These are very small public companies, and only a few hundred or few thousand shares of stock may trade hands in a single day. In nearly ever case, penny stocks are penny stocks because they've had a miserable life as a public company. You can bet that companies don't go public with a share price of a few cents! No, these stocks had to fall long and hard in price to get from their initial offering price of $10 or more a share. Penny stocks are the remnants of the stock market, and while some of these companies may claw their way back to the top, many will languish and ultimately die.

Some investors specialize in penny stocks. Typically, these are aggressive individuals who are willing to speculate, and can tolerate huge losses. Most sensible investors will stay away from penny stocks altogether.

Panic Selling

10

Panic Selling

by Don Cassidy and Donald L. Cassidy from 30 Strategies for High-Profit Investment Success

Your investment lifetime will include a number of market panics. How you act during those extraordinary periods will exert a major influence on your eventual total wealth. Although brief, price panics have lasting financial effect: Ego usually prevents people from reversing themselves rapidly. Once you sell in a panic, it is very unlikely you'll think clearly enough, very shortly thereafter, to buy back in near the lows. Instead, you'll be on the sidelines a fairly long while, recovering your courage to be able to buy again. Your emotional healing process will be enhanced by a return of rising prices, which gradually will win you over. Most who sell near a bottom fail to reenter until well toward the next top.

Selling during a panic costs you money in two ways:

1. What you sell will be sold low, possibly below its cost and certainly at a loss compared with its earlier prices.

2. You'll be in cash during much of the market's ensuing rise, thus missing significant gains during that bull phase.

The first kind of loss, from selling into a panic, is an actual dollar loss visible on your tax return; the second, every bit as real and important, is an opportunity loss—a gain not taken.

 

Never Selling

9

Never Selling

by Don Cassidy and Donald L. Cassidy from 30 Strategies for High-Profit Investment Success

Buying and holding forever will not prove wrong every time, but it is far from a perfect approach in most cases. It is based on false assumptions (either stated or unconscious) and proceeds from laziness and inertia. It also flows naturally from having no plan.

Buying and holding forever is based on four assumptions, all of them false:

• The world will not change for the rest of my lifetime.

• I and my needs will never change as the years pass.

• I always make good buying decisions.

• Stocks, bonds, and funds will rise at a steady pace forever.

Few people would make such assertions and follow them with "and therefore I plan to do such and such." And yet, making investment purchase decisions that turn into lifetime holdings implies confidence that change will no long occur—or requires incredible good fortune. In actuality, we seldom make a buy-to-hold-forever investment decision up front; that holding-forever syndrome creeps up on us afterward.

Index Fund Investing

8

Index Fund Investing

from Investorama.com

An index fund allows you to enjoy the good parts of a mutual fund with little to none of the bad by buying stock in all the companies of a particular index and thereby reproducing the performance of an entire section of the market. An index fund builds its portfolio by simply buying all the stocks in a particular index—the fund buys the entire stock market, not just a few stocks. The most popular index of stock index funds is the Standard and Poor's 500, and there are index funds that track 28 different indexes, and more are added all the time.

An S&P 500 stock index fund owns 500 stocks—all the companies that are included in the index. This is the key distinction between stock index funds and "actively managed" mutual funds. The manager of a stock index fund doesn't have to worry about which stocks to buy or sell—he or she only has to buy the stocks that are included in the fund's chosen index. A stock index fund has no need for a team of highly-paid stock analysts and expensive computer equipment that goes into picking stocks for the fund's portfolio. So the hard part about running a mutual fund is gone.

Investing in stock index funds is often called "passive investing," since the funds don't use the same active management techniques as other funds. Passive investing has two big advantages over active investing. First, a passive stock market mutual fund is much cheaper to run than an active fund. Eliminate those analysts' salaries and an index fund can cut its costs tremendously (and those savings can be passed along to investors in the form of higher returns).

The second main advantage of stock index funds is that they perform better than actively managed funds. Some investors find it incredible when they learn that most mutual funds are flops, at least when it comes to generating returns for their shareholders. In 1998, for instance, 85% of all mutual funds that were set up to beat the S&P 500 failed to meet that goal. When you think about it, that's an incredible statistic—8 out of 10 mutual funds can't beat the market. If the investors in those funds only knew what Armchair Millionaires know, they'd be much better off. Investing in a stock market mutual fund guarantees that you'll always match the performance of the overall market.

Sure, investing in a stock index fund also guarantees that you'll never outperform the overall market, but less than 20% of all professional mutual fund managers can master that task in any given year. Even armed with this knowledge, some investors are convinced that they can pick out one of the funds that will be in the rare 20% club. Armchair Millionaires, though, know that this sounds easy in theory but is actually much harder in practice. If you looked at a list of the top-performing mutual funds for the last several years, you won't likely find many of the same names on more than a few lists. It's not uncommon for a fund to have a "hot" year, but it's very uncommon for a fund to consistently turn in above average performance.

Invest in Mutual Funds that Invest in Stocks

7

Invest in Mutual Funds that Invest in Stocks

from Investorama.com

Most mutual funds invest in stocks, and these are called equity funds. While mutual funds most often invest in the stock market, fund managers don't just buy any old stock they find attractive. Some funds specialize in investing in large-cap stocks, others in small-cap stocks, and still others invest in what's left, mid-cap stocks.

"Cap" is shorthand for capitalization, and is one way of measuring the size of a company—how well it's capitalized. Large-cap stocks have market caps of billions of dollars, and are the best-known companies in America. Small-cap stocks are worth several hundred million dollars, and are newer, up-and-coming firms. Mid-caps are somewhere in between.

Mutual funds are often categorized by the market capitalization of the stocks that they hold in their portfolios. But how big is a large cap stock? Formulas differ, but here is one guideline:

Small-cap stocks < $500 million

Mid-cap stocks $500 million to $5 billion

Large-cap stocks > $5 billion

Equity fund managers usually employ one of three particular styles of stockpicking when they make investment decisions for their portfolios. Some fund managers use a value approach to stocks, searching for stocks that are undervalued when compared to other, similar companies. Often, the share prices of these stocks have been beaten down by the market as investors have become pessimistic about the future potential of these companies.

Another approach to picking is to look primarily at growth, trying to find stocks that are growing faster than the market as a whole or than their competitors. These funds buy shares in companies that are growing rapidly, often well known, established corporations.

Some managers buy both kinds of stocks, building a portfolio of both growth stocks and value stocks. This is known as the blend approach.

Build Your Portfolio through Dollar Cost Averaging

6

Build Your Portfolio through Dollar Cost Averaging

by Laura Maery Gold and Dan Post from Boot Your Broker!

It's a subject that fascinates most investment advisors, but it is, in reality, just common sense. It's the fact that the phenomenon called dollar cost averaging works so well, so consistently, that makes it a subject of endless discussion.

Here's how it works: Each period-say, once a week-you invest the same amount of money-say, that same $100. Over time, say the financiers who track such things, you will make more money with this method than if you try to time your investments to correspond with market highs and lows.

The principle works for a couple of reasons. First, for the real-life reason that if you're a regular investor, you're not waffling endlessly over every investment decision, leaving your money collecting dust in passbook savings. The other reason it works is the theoretical one: that $100 worth of cheap securities is a good deal, and $100 worth of expensive securities is a bad deal. When the market drops, you get more of a good deal; when it rises, you buy less of a bad deal-all with the same $100.

Do You Have What It Takes to Be a Contrarian

5

? Do You Have What It Takes to Be a Contrarian

by Don Cassidy and Donald L. Cassidy from 30 Strategies for High-Profit Investment Success

Markets move to excesses: to extremes of optimism and of pessimism. Success in investing requires that you avoid being a part of the crowd when it acts foolishly during those times of extreme market behavior. To stand against the majority at these times, you'll need to have cultivated in advance a willingness to think and act independently. In short, you will need to have a contrarian mind-set. You need to be alert to fads and be constantly considering unpopular, unconventional possibilities. Opening up to such ideas is an important first step toward practicing contrarianism consistently in your investing.

An investing contrarian is one who looks beyond what seems obvious in the day's or the moment's news. He or she does not deny the accuracy of facts or the existence of present events and clearly established trends. Rather, the contrarian investor tries to escape the noise and step back away from any stampede of the crowd. He or she seeks to discern how important a current news item is; what (particularly what is different) could happen next or has been overlooked; and to what degree current opinion has become a blind consensus.

Being contrarian is not easy, nor is it an attitude of mind that can simply be flipped on like a light switch when needed. This way of looking at the world, especially the emotionally charged world of investments, requires enough discipline to endure loneliness, and means making decisions in conditions or considerable discomfort. This attitude is practiced by only a distinct minority of investors.

Inflation May Be Low Now, But It's Still Important

4

Inflation May Be Low Now, But It's Still Important

by Burton G. Malkiel from A Random Walk Down Wall Street

Inflation in the United States and throughout most of the developed world fell to the 2 percent level in the late 1990s, and some analysts believe that relative price stability will continue indefinitely. They suggest that inflation is the exception rather than the rule and that historical periods of rapid technological progress and peacetime economies were periods of stable or even falling prices. It may well be that little or no inflation will occur during the first decades of the twenty-first century, but I believe investors should not dismiss the possibility that inflation will accelerate again at some time in the future. We cannot assume that the European economies will continue to have double-digit unemployment forever and that the deep recessions in Japan and many emerging markets will persist. Moreover, as our economies become increasingly service oriented, productivity improvements will be harder to come by. It still will take four musicians to play a string quartet and one surgeon to perform an appendectomy throughout the twenty-first century, and if musicians' and surgeons' salaries rise over time, so will the cost of concert tickets and appendectomies. Thus, it would be a mistake to think that upward pressure on prices is no longer a worry.

If inflation were to proceed at a 3 to 4 percent rate—a rate much lower than we had in the 1970s and early 1980s—the effect on our purchasing power would still be devastating. The following table shows what an average 4.8 percent inflation has done over the 1962-88 period. My morning newspaper has risen 1,100 percent. My afternoon Hershey bar has risen even more, and it's actually smaller than it was in 1962, when I was in graduate school. If inflation continued at the same rate, today's morning paper would cost more than one dollar by the year 2010. It is clear that if we are to cope with even a mild inflation, we must undertake investment strategies that maintain our real purchasing power; otherwise, we are doomed to an ever-increasing standard of living.

The Difference Between Investing and Speculating

3

The Difference Between Investing and Speculating

by Burton G. Malkiel from A Random Walk Down Wall Street

At this point, it's probably a good idea to explain what I mean by "investing" and how I distinguish this activity from "speculating." I view investing as a method of purchasing assets in order to gain profit in the form of reasonably predictable income (dividends, interest, or rentals) and/or appreciation over the long term. It is the definition of the time period for the investment return and the predictability of the returns that often distinguish an investment from a speculation.

The consistent losers in the market, from my personal experience, are those who are unable to resist being swept up in some kind of tulip-bulb craze. It is not hard, really, to make money in the market. As we shall see later, investors who select stocks by throwing darts at the stock listings in the Wall Street Journal can make fairly handsome long-run returns. What is hard to avoid is the alluring temptation to throw your money away on short, get-rich-quick speculative binges.

 

?Why Invest at All

2

? Why Invest at All  

by Burton G. Malkiel from A Random Walk Down Wall Street

It is clear that if we are to cope with even a mild inflation, we must undertake investment strategies that maintain our real purchasing power; otherwise, we are doomed to an ever-decreasing standard of living.

Investing requires a lot of work, make no mistake about it. Romantic novels are replete with tales of great family fortunes lost through neglect or lack of knowledge on how to care for money. Who can forget the sounds of the cherry orchard being cut down in Chekhov's great play? Free enterprise, not the Marxist system, caused the downfall of Chekhov's family: They had not worked to keep their money. Even if you trust all your funds to an investment adviser or to a mutual fund, you still have to know which adviser or which fund is most suitable to handle your money. Armed with the information contained in this book, you should find it a bit easier to make your investment decisions.

Most important of all, however, is the fact that investing is fun. It's fun to pit your intellect against that of the vast investment community and to find yourself rewarded with an increase in assets. It's exciting to review your investment returns and to see how they are accumulating at a faster rate than your salary. And it's also stimulating to learn about new ideas for products and services, and innovations in the forms of financial investments. A successful investor is generally a well-rounded individual who puts a natural curiosity and an intellectual interest to work to earn more money

"The Short Answer: "Yes

Street Wisdom

In this series, one of our experts asks, "Would you buy a plant, then never water it?" Of course the answer is no, and we've gathered a collection of articles that provides fertile ground for anyone wanting to know more about these investing fundamentals.

1

The Short Answer: "Yes"

by Burton G. Malkiel from A Random Walk Down Wall Street

Many people say that the individual investor has scarcely a chance today against Wall Street's pros. They point to techniques the pros use such as "program trading," "portfolio insurance," and investment strategies using complex derivative instruments, and they read news reports of mammoth takeovers, and the high profitable (and sometimes illegal) activities of well-financed arbitrageurs. This suggests that there is no longer any room for the individual investor in today's institutionalized markets. Nothing could be further from the truth. You can do as well as the experts—perhaps even better.