Investors in the stock market are always looking for opportunities for making profit in the market. These investors aim to buy stocks low and sell them with a profit at a future date. However, it is essential to know the risks of trading stocks in this manner and to develop a strategy that helps you make a profit on a more consistent basis.
Investors should understand that buying stock low does not imply that they have to invest in only one position, because the goal is to sell the stock at a high price at least with some degree of certainty. The investment should be made in a portfolio of stocks in order to reduce the risk and enhance the return from the investment. This is the key to buying stock at a low price and selling with a good profit.
Spot the best time to buy or sell stocks. Timing is essential for making any successful investment in the stock market. Bad investment timing can be as harmful as good timing can be profitable. A successful approach by many investors is to purchase stock at a time when the market has stabilized after a downturn.
Make a list of the desirable companies that can be considered for investment. To decide which stocks have a potential for growth, look for analyst recommendations regarding the expected stock performance of the S&P 500 stocks. These reports can be obtained from sources such as Value Line and The Wall Street Journal.
Calculate the price-earnings ratio by dividing the market price of the stock with the earnings per share (EPS). The EPS can be conveniently obtained from the income statement of the company or from a finance website such as Yahoo! Finance, MSN Money or Financial Analysis Made Easy (FAME).
Identify the underpriced stocks from the list of price-earnings ratios estimated. A low price-earnings ratio is an indication that a stock has a potential for growth and can be undervalued. However, the ratio for certain stocks can be high and they can still be worth investing in. The use of price-earnings ratio to determine undervalued stocks is just one of the many filters that should be used.
Diversify your stock positions by investing in at least five to 10 stocks for small portfolios in order to keep the transaction costs reasonable. For larger portfolios, you should hold from 20 to 50 different stocks in order to gain maximum diversification benefits.
Beware of problematic behaviour in stock buying practices, such as the conflict of interest between the broker and the investor. In most cases excessive trading does not provide excess returns to offset the transaction costs, but the brokers will tend to advocate trading behaviour to generate transaction costs.
Invest money with a long-term view so that you do not borrow large sums to support your investment. A three-year time horizon is considered desirable for generating a good profit as stock investments tend to be volatile. However, you may sell stock if it reaches a target price at an earlier date. Don’t hold on to losers as they tend to disappoint in the long-run. It is best to sell losers when they fall below a predetermined price.
Locate times when speculative activity is low, as this is a good time for making stock investments at low prices. Once speculative activity picks up, sell stocks at high prices to benefit from excess speculative activity. The Internet technology bubble was a time of speculative excess and an indication for clever investors to sell stock at a high price.