At part 1, I talked about the three questions you need to ask yourself before you invest money in the stock market. In this article, and the next one, I will talk about your definition as an investor or a trader. It is extremely important to know and understand the difference between them, and to put your self under the right title. Not everyone has what is needed in order to be an investor or a trader; a one person can be a great investor but a terrible trader, or the other way around.
In this article I will talk about investors, and how the answers for three questions need to take place in your investing strategy.
What is an investor?
An investor is someone who looks for value, he cares about the company, he needs to know what the company does, he needs to understand the main business of the company and how the market is changing, he also needs to know how changes in the global market effects this company. An investor needs to have some kind of valuation to the price of the company, according to the business it is operating in (different businesses demands different valuations theories). A good example, or maybe even the best example of an investor, is Warren Buffett; you can read more about him at Wikipedia.
Warren Buffett - Best Example of an Investor
The three questions that needed to be answered are the same from part one of this article:
1. What are you buying?
2. Why are you buying?
3. When are you selling?
What are you buying? – The answer to this is the same as specified in part one
Why are you buying? – As we said in part one, this is where the hard work starts. In an investor’s view, he needs to find value in the stock, so what does it mean? It means that he needs to do a valuation to the company and compare it to the market value; the difference between different companies will be the value. When your valuation is higher than the market value you say that there is an upside in the stock, when your valuation is lower you say there is a downside in the stock. After you find a stock with an upside that you think is good enough for you and you decide to buy, it`s not enough to buy and wait till it reaches your target, you need, every reasonable period of time, which changes from business to business, to update your target price according to the changes in the businesses market. This is not a simple task; you need to have a lot of knowledge and information about your company and its market.
When are you selling? – Here you have two choices:
1. Having a stop loss
2. Not having a stop loss
Before I will continue I will define the meaning of stop loss for you – a stop loss, as you can understand from the name, is a point you stop your loss automatically. For example, if you buy a stock for 10$ a share, and the maximum loss you are willing to absorb is 15%, then your stop loss will be placed at 8.5$, means that if the stock drop to 8.5$ or less, it`s automatically being sold.
I think that if you are considering yourself as an investor, and you know and understand what is that you are doing, you don’t need to have a stop loss, but you need to remember that investing can take couple of hours to study, but life time to master. Also, investors are long term players; you can not consider yourself an investor if you are a short term player, because economic theories work only at the long term.
A good use of stop loss is when changes appear in the market or the company after the stock price had slumped. The last crisis we were going thru is a good example of that, but even then – a good investor, that is looking at the market as one big piece, could see, and needed to see, the distortion in the market prices, and could expect the globally slump.
Regardless to having a stop loss or not, you need to constantly analyze the company you are investing in, the market of this company and the global market. Always remember that in the real economy it’s all about mutual influences (I will talk more about it in future articles).
So, are you an investor?
Like everything else in life, it’s all starting with a decision. Not everyone can be an investor, remember that if you put money in a company, it doesn’t necessarily make you an investor – it only makes you to someone who invest money in the company or bought their stock, nothing more than that.
In the 3rd part of the article, I will discuss a little bit about traders and trading.
The CEO Game.