There is nothing to distinguish one stock of BHP from another, which makes the stock market highly liquid; that is, many stocks can be sold at a moment’s notice and my stocks of BHP are worth the same as your stocks of BHP at the same time. Stocks do not require a great deal of capital to get started and transaction costs are extremely low. Stocks may or may not pay a dividend ( a cash payment to shareholders from company profits). If they don’t, you typically buy the stocks for their capital gain component only.
A characteristic which sets stock investments apart from other types of investment is the way they perform in different economic conditions. Stocks are capable of performing well in any inflationary environment and this is a major difference to either fixed interest or real estate. The key thing here is that whatever inflation is doing, the stock market is so broad and has so many sectors that some areas will be capable of very high performance, regardless of economical or political conditions.
This ability to perform under various inflationary conditions is a major reason why stock market investments should be an essential component of everyone’s investment and retirement strategy. Unfortunately, many people do not invest in stocks for fear of losing money. Fears about volatility should not put off potential investors. Volatility is the key to how money can be made consistently from the markets. Markets have always risen and fallen. Successful investors are not afraid of the market. They learn to understand it and how to work with it. We will be covering some simple and effective asset protection strategies later in this series.
Regardless of which method you use to choose your shares, the most successful share traders and investors adopt a similar approach when it comes to reviewing the market, that is, a Top-Down Approach.
A top-down approach refers to looking at the performance of the major global economies, such as the US and European markets. We then focus on the overall performance of our local market and see how it is performing in light of the other markets around the world. We then study the performance of the different sectors that make up our local market, such as mining or retailing. Finally, we compare and study the individual shares that make up the sectors.
By adopting this approach, we can gain a fair idea of how individual shares will perform in comparison to the larger markets around the world. Looking at the performance of just one company can be likened to studying just one tree in the forest. For example, looking at the graph of a particular share may show a sudden fall. Does this indicate bad news or an adverse shift in fundamentals within the company, or was the company simply caught up in a general market correction? It is important to understand what is happening to the forest and for that, broader measures are needed.
If studying the forest is important for the average investor or trader, it is vital for institutions and managed funds that have large portfolio holdings. The huge growth of the managed funds industry requires not only that all stock exchanges provide a broad benchmark to measure market movement, but several sub-indices as well, to show how each segment of the overall market is performing in relation to the whole.
To study the performance of different international markets, we use indices. An index is simply a benchmark designed to measure the movement of some broad compilation of shares.
It is for the exchange concerned to decree which shares or commodities are included in an index, how they are weighted (the basis for comparison between them) and what base-line is used initially to provide their benchmark. Once this figure has been set and the reference point established, then future movements will alter this figure up and down, in accordance with what is happening in the underlying markets.
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