Understanding market, strategies necessary to successful investments

By Chris Goodmacher
Daily Bruin Contributor In October, Henry Chang, internal vice
president of the Undergraduate Investment Society, started
investing in some stocks by swing trading. Two months after he
began investing, his portfolio had turned 200 percent profit. He
then margined his portfolio at 50 percent and threw all his money
into one stock. The stock ended up missing an earnings estimate, so
the market cut the price of the stock about 45 percent and since
the account was margined at 50 percent, his losses were amplified
to 90 percent. First, what does all this mean? And second, how can
you avoid a similar situation? The answer to both involves
understanding, and sticking to basic precepts of investing. Chang,
a second-year tyronomics student, said he broke one of the cardinal
rules of investing, which is diversifying. “Diversify.
Don’t put all your eggs in one basket,” said Eric
Sussman, professor at The Anderson School at UCLA. The idea behind
diversification is to invest in a variety of stocks. This way your
portfolio, which is a group of investments you have, cannot be hit
as hard. For example, if you invested heavily in a few technology
stocks, if might be a good idea to put some money elsewhere, like
insurance stocks, in case the tech stocks plummet for some reason.
Also, one should remember that “patience is really a virtue
when it comes to investing,” Sussman said. When it comes to
investing, yes, but what about those day traders you hear so much
about, that frantically make several trades a day? There are two
schools of thought when it comes to playing the stock market and
different techniques within each of these schools.

Day trading vs. investing The first major ideological division
is between day trading and investing, which is buying and holding
onto a stock for long-term value. “With day trading, you sit
for the day, make 5-20 trades, look for movement in the stocks, and
you buy and sell quickly,” Chang said. Day trading is
becoming more and more popular recently, as online brokerages have
given day traders the ability to make trades quickly and cheaply.
Despite its popularity, however, many experts liken it to gambling.
“Day trading is not investing; I am not a believer in
it,” Sussman said. “If you want to gamble, hop on
Southwest and go to Vegas.” Another practice that has gained
popularity is swing trading, which is holding on to a stock for a
week or two until it hits a price target and then selling,
according to Chang.

Technical vs. fundamental analysis If you’re a day trader,
you most likely use technical analysis to decide your trades.
“Technical analysis is saying you’re able to discern
trends in stock price movements,” Sussman said. Technical
analysis is looking at graphs for patterns in stock price movements
and then trading on those patterns, according to Chang.
“It’s total hogwash, studies show technical analysis is
worthless,” Sussman said. Fundamental analysis, on the other
hand, is the tool of long-term investors, and it means
“looking at the fundamentals of a company: what the financial
statements look like, the company’s future plans,”
Sussman said. “This is what the investment bankers look
at.” “If you’re going to analyze a company,
that’s what you should do,” he added. Chang’s
company missed an earnings estimate, meaning they made less money
than they said they would. Investors took this as a bad sign, and
the stock value plummeted accordingly. Despite advice from most
experts to concentrate on fundamental analysis, technical analysis
is common practice. “A recent survey showed 50 percent of
investors do fundamental analysis, 50 percent of investors do
technical analysis,” Chang said.

Deciding where to invest If you have decided to invest for the
long term, there are three factors that determine what you should
invest in: your investment objective, your risk tolerance, and your
time horizon, said Steve Weinberger, financial consultant for
Heller Capital Resources. Your investment objective is determined
by thinking realistically about how much money you are looking to
make. This leads to figuring out your risk tolerance, because the
higher the risk, the greater the potential reward and the potential
loss. Then, the time horizon is when you will need the money by
““ whether you’re investing long or short term.
“(These factors) will determine if someone invests in a
conservative utility stock versus a volatile high tech
stock,” Weinberger said.

Growth vs. value Investors are further divided into two camps
““ growth and value investors. Growth investors believe in
buying stocks with above-average earnings growth no matter what the
price. Value investors look exclusively for bargains, or stocks
that are trading at a discount to their usual valuation, according
to finance.yahoo.com. “I believe you can’t have value
without growth; to have value, you need growth,” Sussman
said. Invest in a stock you believe is undervalued, because it has
growth potential, Sussman advised.

Brokerages The brokerage an investor uses to execute their
trades is also an important factor. The main choice is between
full-service brokers and discount brokers, which include most of
those online brokerages. A full service broker, such as Morgan
Stanley Dean Witter, offers a vast range of services and the
opportunity to consult with a real broker in person. The things
people look for in a broker are knowledge, a good relationship with
clients, and a history of client portfolios that had similar risks
and returns as what the client is looking for, Weinberger said.
This added service, however, comes with a cost. “The biggest
complaint about brokers is that they make money by making you make
trades,” Chang said. They work on commission, so the more
trades you make, the more money the broker makes. “There may
be a conflict of interest there,” Chang said. Online brokers,
alternatively, offer the ability to make trades cheaply and with a
click of the mouse. They make money by charging a transaction fee,
which is cheaper than most brokerage commission fees. They can
charge anywhere from $5 to $25 a trade, according to
finance.yahoo.com. The downside, of course, is the fact that you
have to handle everything yourself. “Most people can do
better on their own if they had the wherewithal and the
desire,” Sussman said. “The evidence is
overwhelming.” A concern for many people who are interested
in investing is how much money they should start with.
“(Invest) any disposable income that you would not need for a
minimum of one year,” Weinberger said. As a practical matter,
one should buy stocks in round lots, meaning batches of 100.
Brokers don’t like it when you ask to buy one share,
according to Sussman. Also, with transaction fees or commissions,
buying stocks in smaller amounts is unprofitable. Most experts
advise beginning with at least $1,000. Many brokerages have minimum
amounts that you need to begin trading, such as Ameritrade, an
online brokerage that requires investors to put in $500 to open an
account.

Strategies It is also important when you begin investing to
understand what the company you’re investing in does.
“So many people don’t know what the company
they’re throwing thousands of dollars at does,” Sussman
said. “How many people invested in Cisco know what a router
is?” One way many investors get started is by investing in an
index fund. There are indexes that consist of various stocks whose
collective performance, their average, is used to indicate the
health of the market and the economy. The Dow Jones Industrial
Average tracks the 30 biggest companies in the U.S; the NASDAQ 100
index tracks 100 major technology companies; and Standard &
Poor’s 500 Index is an index of the 500 largest companies in
the U.S. The term “bear” market that you hear investors
use refers to a general market where most of the stocks are going
down in value, while a “bull” market is one that is
gaining in value. The S&P 500 has a history of giving an
average long-term yield of about 11 percent annually, Chang said.
This means that all those companies together go up in value an
average of about 11 percent each year. So, if you were to invest in
the S&P 500 index fund, you could expect to see the same level
of growth. If your company offers dividends which are portions of
the company’s earnings that are paid out directly to
investors, you might want to take advantage of their dividend
re-investment plan, or DRIP. “(With DRIPs,) instead of
receiving cash dividends, they take the money you would receive and
re-invest it in company stock,” Sussman said.
“It’s good to do if the company offers it and it makes
sense to you.” What Chang did with his stock that especially
hurt him was margining, a more advanced investment technique. It is
basically borrowing money and buying stock with that money. For
example,if you wanted to buy a certain amount of shares, you could
buy 50 percent yourself, and borrow money to pay for the other 50
percent, according to Sussman. This is exactly what Chang did, and
with any loan, of course, you have to pay interest. All this
accounts for Chang’s loss.

Stick with the basics There are countless other strategies that
amateur and professional investors use. If you understand the basic
concepts and stick to the precepts, however, you should be fine.
Chang was able to rebound from his loss by going back to the
basics. “I was able to double my money in 10 weeks,”
Chang said. “I took a more balanced approach.” “I
diversified a little and took out a little of the risk,” he
continued.

HOW TO READ A STOCK LISTING:

This is an example of a stock traded on the New York Stock
Exchange as listed in the Los Angeles Times on Feb.8. In this case,
our random example is the Walt Disney Company.

SOURCE: Los Angeles Times, finance.yahoo.com

Original by VICTOR CHEN/Daily Bruin Web Adaptation by MIKE
OUYANG/Daily Bruin