Many investors in the stock market associate the chaos you can witness in commodity pits with brokers trading back and forth by yelling and waving paper at each other. However, the stock market is not anything like that.
The reality is most stock trades today are from one computer to another and they can happen in an instant. Traders who move in and out of the market on price changes make a romantic picture, but the reality is unless you are a dedicated professional the odds of you making money with a short-term trading strategy are almost nonexistent.
Professional traders have access to powerful software and hardware that amateur investors can't begin to match. The lesson is quite simple; if you want to make money in the stock market you should avoid trading and focus on long-term investing.
Amateur traders often don't realize the tax implications and the commissions they have to pay with frequent trades. These expenses can suck most of any profit you are lucky enough to make out of your pocket and into your tax bill and your brokerage fees.
It is possible that as a frequent trader, you will have to net 50% more than another investor who was holding for long-term. The odds that you can do this on any consistent basis are almost too bad to mention.
You will hear traders talking about buy-and-hold investors as the dumb money that stays in the market when it's sinking fast. What they don't tell you, is study after study shows that investors who stay in the market rather than trying to time the top and bottom, come out the other side in better shape.
A buy-and-hold strategy does not mean buy and be stupid. Long-term investors need to monitor their choices on a regular basis to make sure nothing fundamental has changed about the company that would question your decision to buy it.
Companies that are market leaders today can be tomorrow's failures. We live in a dynamic, global economy where conditions change rapidly. Foreign competition, new technology, restrictive economic markets and other factors can quickly change the financial health of yesterday's market leader.
There are a couple times you need to reassess your decision to buy a stock. The first one is when the stock's price has dropped by in amount you predetermined when you bought the stock. For example, you may feel that a stock is a good buy as a long-term investment at $30 per share. When you buy the stock, you need to decide at what point does the price have to fall to before you will consider selling. This acknowledges that some stocks may fluctuate several points during each day's trading, especially if they are popular with larger investors. However, a downward trend may indicate that something fundamental has changed with the company.
When the stock hits that point or appears to be trending downward and will hit that point in the near future, you need to reassess the reason you bought the stock. You have several options when you reach this point. If your reassessment can find nothing that fundamentally changes the value of the company, it may be time to buy more shares at a lower price if you are confident the price decline is not grounded in a fundamental flaw of the company.
Only other hand, if you discover that the company has failed to stay on top of its market or lost a competitive position or something else has changed that would lead you to believe this is not a good stock to own, it may be time to sell and move on.
Under most circumstances, you can review the stocks you own a couple of times a year. Some investors may want to stay more in touch with their investments and choose to re-examine them more often.
If your stock has made a dramatic rise and you can't see any fundamental reason or change in the company, it may be time to sell
As a general rule, when everyone else is selling the stock you should consider buying at a lower price and when everyone else is buying the stock you should consider selling all or part of your holdings and reinvest your profits.
This is difficult for many investors, since our inclination is to buy when the market is rising and sell the market is falling. If your strategy is to hold for long term and you have a plan that addresses either a rising stock or a falling stock, you may avoid becoming caught up in the markets frequent insanity.