Stock Market Tips

When you buy a stock, you’re literally buying a piece of a company. That piece of paper represents a share of ownership, which gives you a claim to that company’s assets and earnings.

Assess your financial situation.

Before you invest, make sure you have the funds available to make the commitment. A good rule of thumb is to have little or no debt (especially credit card debt) as well as six months’ worth of living expenses in an emergency savings account (more if you have a family). If you’ve got that solid financial foundation, you may be in a position to begin investing in stocks.

Think in terms of risk vs. return.

It’s simple: If you want higher returns, you’ll have to buy stocks that carry more risk. If you don’t want to take on risky stocks, you’ll have to settle for those with lower returns. Most investors fall somewhere in the middle of being extremely risk-averse and risk-ready.

Don’t get emotional.

Investing is a long-term commitment, usually meant to bolster retirement funds—not fund your next big-ticket purchase. Investors who trade too often based on market fluctuations are making it harder on themselves. Over the short term, market behavior is often based on the alternating virtues of enthusiasm (“Everyone loves this new product!”) and fear (“This looming scandal is going to be very bad for business.”). But over the long term, the bottom line—company earnings—will determine a stock’s value, and companies with a solid foundation can withstand quite a bit of flack.

Assess a stock’s volatility.

To anticipate a company’s volatility (and therefore avoid your own emotional reaction to a sudden drop in stock value), look at its rolling 12-month standard deviation over the past 10 years. In laymen’s terms, look at the stock’s average performance over that time span. A normal standard deviation is about 17%, which means that it’s completely normal for that stock to increase or decrease in value by 17%

Buy low, sell high.

The advice seems obvious—buy stocks when they’re priced lower, sell them when they’re priced higher—but it can be as difficult as walking away from the Vegas blackjack table when you’re on a winning streak. To protect your stock portfolio from above-average risk, harvest the stocks that have done well and put those gains into stocks that have underperformed. It seems counterintuitive, perhaps, but that’s the essence of rebalancing a portfolio. So if your stock’s standard deviation is 15%, and it drops more than 15% in a short span of time, it may be a good time to rebalance and buy more of that stock—because you know it’ll likely go up again.

Understand how market expectations work.

Stock price is based not on performance but on how investors think it will do. We all hear the rags-to-riches stories of stock investing: a little-known company hits it big and thereby makes all of its stockholders rich. But notice that first qualification: the company was little-known. Too many investors fail to undetsand that the market’s expectations for a given company are built into the stock’s price, i.e., it’s not enough to invest in a company that will have above-average growth. You need to find a company that will grow more than the market expects it to.