The Path of the Investor

Well, our power is back on and the air conditioner has been fixed. The Washington D.C. area is slowly returning to normal under a hot a humid sky. So, let’s return to the business of blogging. I found an excellent introductory article, The Investor’s Path to Trading by Mark Eidem in the current edition of Charles Schwab On Investing. It is one of those articles that really doesn’t say anything you don’t already know, but puts a process into a succinct, easily understood package. The author observes that making any investment, something you choose to hold for more than a year, or trade, a position held for less than a year follow the same four step process.

1)Screen: Find new companies to consider.
2)Analyze: Research prospective companies using both fundamental and technical analysis.
3)Execute: Plan trades in advance.
4)Monitor: Trade your plan with discipline.

Screeen:

There are over 3,000 stocks trading on the New York Stock Exchange alone. How do you decide which stocks to study? Here is a very incomplete list of methods for finding stocks to investigate.

1)Search websites like the Motley Fool and Seeking Alpha for investment idea.
2) Watch TV shows Jim Cramer’s Mad Money (not my favorite)
3) Subscribe to a reputable newsletter that holds the same investment philosophy you are attempting to master.
4) Talk to people who know more than you know (be careful when dealing with commission salesmen)
5)Learn how to use screening tools provided on just about every brokerage house website.

Analyze:

Now you have reduced the number of stocks for investigation to some reasonable number. The brokerage houses provide free reports on companies by Standard and Poor’s, Reuter’s, Argus, Credit Suisse, and Ned Davis Research. These are very good tools. Not only do they provide an educated opinion on a particular stock, but in studying these reports you will learn the process these experts use in assigning a rating to a particular company. As you gain confidence in your own ability you will begin to study different ratios without training wheels. I am fond of the P/E ratio, a history of dividend growth, the percentage of profits paid out in dividends, and cash flow. I am still learning. As the song says, You got to know when to hold ’em, know when to fold ’em, Know when to walk away and know when to run. Every investment is a good investment. Every investment is a bad investment. The difference is timing. Technical analysis is the art of determining when to buy and sell. Spend some time learning at least the basics of reading a chart.

Execute:

It is time to execute the trade. How much do you want to invest? Except for your first few buys, that of a necessity will constitute a large percentage of your entire portfolio, keep any single position under 3% of your total portfolio and you will likely stay out of trouble. Remember to diversify across sectors. If you had too many positions in dotcoms, even if each individual position was small, the crash of 2000 would have destroyed your portfolio. Experts recommend setting a stop loss price the day you buy the stock. This will automatically trigger a sale limiting your loss. You will make mistakes. Generally the rule is stop losses, let profits run.

Monitor:

Keep revisiting your decisions. Market conditions change. What was a very good idea two years ago may not be such a good idea today. A rule of thumb? If you would not buy a stock you own in today’s market, you might should consider selling it. The reverse is also true. Revisit stocks you have sold. As you buy and sell shares in a particular company you will develop a sense of how it moves and what drives its profitability.

There are several keys to making this work. First, persistence. Keep saving and investing through good times and bad. Never give up. Second, maintain discipline. Fear and greed are your enemies. Find a discipline that reflects your personality and stick with it. Readers of this blog know I am learning the art of value investing. Value investing consists of buying an established dividend paying company (large or small) at what I perceive to be a bargain price, then holding it forever. Of course if the price goes too high I will sell the stock or if the price crashes and doesn’t come back I will sell the stock, take the tax loss, and move on.

Now, Let’s be careful out there.