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Six steps to think like a smart stock market investor

22 August 2016 12:00 am - 0     - {{hitsCtrl.values.hits}}

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Number crunchers and quantitative analysts make a lot of money in the stock market. However, the most successful investors also use psychology as a tool to enhance returns. Thus, the article will provide some tips that can help you improve your investing mindset, set your thinking straight and start thinking like a smart stock market investor.
 

Tip No.1: Avoid panic
Panic is an emotion that causes us to make irrational decisions - to sell a stock when it should be held or to buy a stock when perhaps it should be sold. 


Panic buying is the hot-tip syndrome, whose symptoms usually show up in buzzwords. You see a stock rising and you want to hop on for the ride, but you’re in such a rush that you skip your usual scrutiny of the company’s records. After all, someone must have looked at them, isn’t it? Wrong. Holding something hot can sometimes burn your hands. The best course of action is to be diligent. If something sounds too good to be true, it probably is.
Panic selling is the ‘end of the world’ syndrome. The market (or stock) starts taking a downturn and people act like it’s never happened before. Symptoms include a lot of blaming and despairing. Regardless of the losses you take, you start to get out before the market wipes out what’s left of your retirement fund. The only cure for this is to be level headed. If you did your due diligence, things will probably be under control and a recovery will benefit you nicely. Tuck your arms and legs in and hide under a desk as people trample their way out of the market.


Of course, our basic instinct to panic can’t be eliminated altogether, so the key is to control it. Jim Cramer (he is an American television personality, former hedge fund manager and best-selling author) attributes some of his success to the fact that he has always believed that he was just a pay check away from the unemployment line. But rather than letting panic eat him, he harnessed it. He used the emotion to drive him to conduct more thorough research and to get a leg up on the competition. Anyone can use this same strategy and resolve to become better investors.


Finally, try to take bad market news in stride and thoroughly analyse a situation before acting on it. By delaying an investment decision by even a few minutes, your thought process can become infinitely clearer.
 

Tip No.2: Consider near-term catalysts
While stock market gurus such as Peter Lynch and Warren Buffett have encouraged investors to focus on the longer term, there is something to be said for timing a purchase or a sale around a potential near-term catalyst. 
For example, imagine a long-term investor purchasing shares of company ‘Y’ because the stock looked ‘cheap’. What if the investment lost 50 percent of its value within a year? Had that same investor heeded the near-term risks associated with the stock and waited until the stock levelled off before buying, he or she would have been up on the investment.


Invest for the long haul, but consider the possibility that certain events could have a positive or negative impact on your investment; use that information to assess when to buy.
 

Tip No. 3: Have a fallback position
Investors should always have a fallback position in mind, whether it’s setting a mental stop loss at a price 10 percent or 15 percent below their purchase or identifying a hedge that can be used at a future date against a particular position. This doesn’t mean that you need to act on these thoughts, but you do need to identify these fallback positions in case they’re needed. 


For example, if fuel prices were expected to rise and you owned stock in an auto company, you might want to think about hedging your risk by buying shares in a domestic oil company. Again, the point is to always have a way out of a position or a way to mitigate your risk. 
 

Tip No.4: Sharpen qualitative skills
The most successful investors make their money not by crunching the numbers found in annual reports but by inferring and deducing things from press releases, management’s public comments and other shareholder correspondence.


Ben Graham was a quantitative analyst, choosing only to make investment decisions based on the numbers that were publicly available to everyone (standard income, balance sheet, cash flow statements, annual reports, etc.). On the other hand, Warren Buffett, although one of Graham’s students, thought that qualitative analysis was what “really made the cash register sing”. Now, Buffett started his career as much more of a ‘numbers guy’, paging through Moody’s manuals one stock at a time and looking for bargains. He became more qualitative over time as his skills developed.
 

Tip No.5: Know when to swim with the tide
Sometimes it pays to go against the prevailing trend. However, in most situations, the average investor should not necessarily swim against the tide. In other words, if a stock is falling, it’s often better to wait until it levels off or buying pressure resumes before jumping in.


In many situations we have been told to ‘think outside the box’ or ‘go against the grain’, making the concept of following the herd, very difficult for some investors to grasp. In a way, it also goes against human nature. If we see a stock getting pummelled, we want to get out before it goes down even further, even if it’s not in our best interest. 


In order to avoid this instinct, to buy when everyone else is selling or to sell when everyone else is buying, the investor must focus on the fact that there are countless opportunities in the stock market at any given point in time. Investors should also keep in mind that recent history suggests that jumping the gun ahead of the crowd is more often than not a losing cause.


So how can you figure out whether to go with the crowd or not? The short answer is to do your homework and confirm the herd’s position. Maybe you should take a look and find out if there is a reason why a company’s stock is so out of favour with the market. More often than not, a slump in a stock’s price is probably justified by some underlying fundamental reason.  
 

Tip No.6: Seize opportunity
Patience and thorough analysis is important but once the analytical process is complete, go for it! Inactivity or paralysis is just as deadly as is acting in haste. 


Make sure that you stick to a formal research process. In other words, before a purchase, resolve yourself to reviewing all of the financials, comparing the company to its competitors and researching on the company. Then, after the homework process is complete and you have a fallback plan, commit to taking action.


Bottom line
It helps to be a ‘numbers person’ but an investor’s ability to extrapolate ideas, infer things from shareholder communications and to control his or her emotions is of far 
greater value.

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