In the review of asset classes for an individual, it is obvious that the ability to make money from the stock market is an important skill to possess over the long run. Executed correctly, the individual can enhance his own wealth significantly. Fund managers of many unit trusts and mutual funds have long recognized the importance of the stock market to generate profits for their funds. The challenge for both the fund managers and the individual is how to make money consistently from the stock market.
The purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers. Apart from providing information on listed securities, the stock market is an important source for companies to raise capital. A successful stock exchange provides investors with the ease to quickly buy and sell securities.
For the individual, there is plenty of ‘noise’ in the marketplace. To get the investors’ attention, the noise can come from many sources including a mix of financial journalists attached to newspapers or magazines, television commentators, stock analysts, stock brokers and even from chat rooms and message boards. Some tips may pan out to be correct but many have over time been shown to be just noise without much correct substance in their content.
The efficient market hypothesis (EMH), commonly presented in formal investment courses, indicated that share prices are affected only by fundamental factors such as profits or dividends declared by companies and that all price movements are non-trending and random. However, there are other studies especially from technical analysis that shows that there are periods where stock markets do trend over periods of some days or weeks.
Sometimes prices of stocks have been shown to move based only on the sentiment of traders or investors, sometimes without any financial justification. Some researchers put it down to psychological factors or even the phenomenon of ‘group think’ that can result in exaggerated stock price volatility. Many a time, markets have been swayed by adverse press reports, circulating rumors and unverifiable tips.
How then can the individual rise above such a situation and be able to differentiate what is correct and what is not correct?
One safer way is for the individual to learn a disciplined, systematic process of investing or trading the stock market. In the course of such learning, the individual should amongst other things, likely learn how to read stock market cycles, how to pace between risk versus returns, how much trading capital to use per trade, how to use stop-loss orders, how to follow trends, how to set up defined trading strategies and plans and how to diversify.
There is also the issue of whether the individual should be an investor or a trader. The investor usually puts capital into the stock market under the assumption that the investment will increase over time. In a bull market the chances are better as strategies of buying low and selling high should work out well. But there are also protracted periods in a bear market where share prices even of good stocks can get knocked down badly. In such situations, a knowledgeable trader is more likely to profit as there are ways to make money when the market goes up as well as ways to make money when the market tanks.
Equipping yourself with a trading process does not automatically mean you can always make money in the stock market. It does provide some assurance that compared to less informed investors, you have a higher probability of winning. Afterall, winning in the stock market like most investments, is a game of odds. You want to give yourself as high a chance of winning and surely you do have that higher chance if you have a disciplined process and knowledge to guide you along.
Roland Lee
