How To Invest In Shares
May 27, 2010
3. Why You Need An Investment Strategy
If you're going down the DIY stock-picking route, then you'll need to get a share selection strategy in place. Because if there's one certainty on the stock market, it's the certainty of losing money by haphazardly picking individual shares on a whim.
It's the very rare investor that can consistently pick stock market winners solely through gut feel or intuition. Alternatively, forming a set of sensible guidelines and having the discipline to stick to them should keep you involved in more suitable investments.
Whether it's considering companies of a certain industry, or keeping to companies that exhibit certain financial criteria, remaining with what you know best and feel comfortable with should limit any stock market heartache.
Clear and independent thinking
The Motley Fool recognises that, for the novice investor, the stock market can be a bewildering place. There are hundreds of different companies out there, all spread over various industries. And with every company issuing a never-ending stream of corporate news and mystifying accounts too, there's a real danger of "information overload".
However, applying a clear investment philosophy leads to better investment decisions. The information overload is curtailed, as the number of investment possibilities reduces significantly. Becoming a market-beating investor means finding a suitable investment style and then continually developing it further.
Which strategy should you choose?
There is no one investment strategy that suits everyone. A good strategy is one that works for you by playing to your strengths and eliminating your weaknesses. For instance, if you're good with numbers then a strategy that focusses on detailed analysis of company accounts may suit you. A good strategy should also be simple to follow, easy to summarise and tell you when to buy and when to sell. And of course it should be based on sound investment logic.
Value investing is one strategy that has worked well over time and has a large following at the Fool. Simply speaking, you buy shares when they appear cheap -- as measured by a few financial ratios such as P/E and yield -- and then you sell the shares once they become more expensive.
Other popular strategies include focussing on a particular sector of the market that you know well. The idea here is that by researching an area in depth you'll gain an edge over other investors in the market. Closely related to this idea is the idea of 'top down' investing. Here you identify a sector which you think will benefit from a major trend, and then pick the best companies within that sector.
Off the chart
One approach that we don't favour at the Fool is charting or technical analysis. This is the practice of using price charts, and other technical data like the volume of shares traded, to predict what will happen in the future. Not everyone agrees with us, and that's fine, but we don't think it really works for shares. You end up buying and selling too frequently, hence racking up expenses that eat into your returns. For similar reasons, we're not overly fond of strategies that use a 'stop loss', which is when you automatically sell your investment should it drop by a certain percentage from your buy price.
Trial and error
Finding the strategy that works best for you is likely to involve some trial and error. You'll probably have to experiment with a few different ones before you settle on the one you prefer. The world of investment has its fashions so sometimes some strategies work better than others. Indeed, when the stock market is rising most strategies will do well. This is why it's a good idea to benchmark your performance against the overall market. This way you can see if all your effort was worthwhile and it can help you make sure you don't mistakenly attribute your investment success to skill rather than luck.