To be successful with any investment strategy, you have to start out with an investment philosophy that is consistent in substance and one that corresponds not only to the markets you decide to invest in but your to your personal and individual characteristics as well.
What is an Investment Philosophy?
An investment philosophy is a logical method of thinking about markets, how the stock exchange system works, how and when you should buy or sell and even the types of mistakes that you believe consistently underlie investor behavior. Most investment strategies are fashioned to capitalize on mistakes caused by some or all investors in pricing stocks. Those errors themselves are determined by far more canonical presumptions about human behavior and investment philosophies.
The following broadly identifies the distinct investment philosophies and the purpose each philosophy has on the investor.
1. Fundamental Analysts
The basic idea in fundamental analysis is that the genuine value of a stock can be associated to its financial features of the business: its growth expectations, risk visibility and cash flow statements. Any deviance from this straight value is a sign that a stock is under or overvalued.
Fundamental analysts would be conceived a long-term investment strategy. Since investors that are employing this plan of attack are commonly taking a great number of ‘undervalued’ stocks in their investment portfolios, their hope is that, on the average, these investment portfolios will serve better than the marketplace to make them profit.
2. Franchise Buyer
The school of thought of a franchise buyer is better conveyed from an exclusive successful investor: Warren Buffett.
“We try to stick to businesses we believe we understand,” Mr. Buffett once wrote. “That means they must be relatively simple and stable in character. If a business is complex and subject to constant change, we’re not smart enough to predict future cash flows.”
Franchise buyers focus on a couple of businesses they understand considerably, and seek to take on undervalued business firms. Oftentimes, as in the instance of Mr. Buffett, franchise purchasers maintain influence on the management of these firms and could alter financial and investment policy within the company.
As a long-term strategy, franchise buyers are appealed to a specific business enterprise since they consider they are undervalued. They are also interested in how much additional value they can produce by restructuring the business organisation and operating it correctly.
Chartists think that prices are motivated as often by investor psychology as by any fundamental financial variables. The information accessible from trading (price movements, trading volume, short sales, etc.) establishes an indication of investor psychology and emerging price movements.
They propose that stock market prices act in predictable patterns, that there are not adequate marginal investors capitalising from these patterns to eliminate them, and that the mediocre investor in the market is motivated more by emotion instead of by intellectual analysis.
4. Information Traders
Stock prices move on information about the public company that is released. Information traders seek to trade in advance of fresh information or concisely after it is divulged to financial markets. They stick to the buying on good news and selling on the bad philosophy. These traders trust they can foresee information announcements and guess the market response to them better than the common investor in the market.
For an information trader, the direction is on the kinship between information and alterations in value. They might purchase an ‘overvalued’ stock if they consider that the succeeding information announcement is going to drive the price to go up, because it bears better than anticipated news.
The relationship between how undervalued or overvalued a company represents and how its stock price responds to current information plays a function in investing for an information trader.
5. Market Timers
Market timers believe that the reward to foretelling turns in the stock market is a lot more outstanding than the payoffs from stock picking. They contend that it’s more painless to forecast market movements than to choose stocks and that these predictions can be founded upon elements that are noticeable in the markets.
Market timers employ tools that can be used to assess all stocks, and the outcomes from the cross section can be applied to ascertain whether the market is over or under valued. For instance, as the number of stocks that are overvalued, utilizing the dividend discount pattern, increases proportional to the number that are undervalued, in that respect may be reason to think that the market is overvalued.
6. Efficient Marketers
Efficient marketers consider that the market value at any point constitutes the most dependable appraisal of the true value of the business firm, and that any endeavor to exploit detected market efficiencies will cost more than it will attain in excess profits. They presume that markets aggregate data promptly and precisely, that marginal investors quickly exploit any inefficiencies and that any inefficiencies in the market are stimulated by friction, such as transactions costs, and can’t be arbitraged away.
For efficient marketers, a valuable practice is to decide why a stock sells for the price that it does. Since the fundamental premise is that the market price is the most beneficial approximation of the true value of the company, the objective becomes determining what assumptions about growth and risk are implied in this market price, rather than on finding under or over valued firms.
What investment philosophy do you employ when trading in the stock market?