ON THE MONEY: Approaches to investing in the stock market

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There are five basic investment strategies for investing in the stock market, and they are: market timing; buy and hold; contrarian investing, value investing, and growth investing. These approaches are not mutually exclusive, since, more often than not, an investor will use one or more strategies at the same time, based on their investment objectives.

Marketing timing tends to emphasize market trends to produce quick profits from short-term changes in stock prices. This is the technique used by day traders and professional investors, and they employ a variety of models and indicators to signal when to buy and when to sell. It sounds good, but there is no long-term documentation of the validity of this approach. I certainly would not recommend it for an investment tyro.

Buy and hold is a more conservative approach, since the investor takes a long-term view of the market by selecting stocks that will provide long-term value. Market or economic trends are not taken into consideration. Once a security has been purchased, it is held through both bull and bear markets. If the stock is expected to perform well over time, this approach can be quite effective. Unlike market timing, this strategy has low transaction costs (the fee that you must pay to buy or sell a security) and, you do not have to spend an inordinate amount of time maintaining your portfolio. This is the method that Warren Buffet employs in his portfolio, and who can argue with his success?

Contrarian investing means buying a stock when others are selling and vice versa. Contrarians know that when a stock is “hot,” there are more buyers than sellers. Once prices increase, most investors who wanted to buy the stock have already done so, and with no new purchasers, the stock may lose momentum, causing a chain reaction of more selling and less buying, and the stock price drops. The same phenomenon occurs when a stock has bottomed out, but only in reverse.

Value investing means searching for stocks and industries that are out of favor with other investors yet have good growth potential. The value investor will examine such factors as assets, sales, earnings history and outlook, stockholder equity, and compare those factors to the current price of the stock. If the stock is found to be undervalued, it is purchased. Value can come about from low price-earnings ratios and high dividend yields, among others.

Growth investing is based on finding industries that have substantial future growth, and then investing in the most attractive companies within that industry. The investor is usually interested in a medium-sized company that is poised to generate earnings that are greater than the market as a whole.

If you are an investing newbie, there is a great resource that you can avail yourself of to educate yourself about investing. It is generated by the leading investment research in the U.S. (and probably the entire world), Morningstar. For more information, visit morningstar.com/start-investing/classroom.