The Stock Market Essay, Research Paper

The Stock Market

Have you ever noticed how everyone thinks they know what is best for you?

Everyone telling you what to do when you are the only one who knows what is the best

for you. You maybe wondering what this is about, would you believe me if I told you it

is about the stock market. Well it is, you may have thought that this had nothing to do

with the stock market, but actually it is everything about the stock market. Why trust

everybody else when you can invest yourself ? Develop your own system of trading

and get started. This may raise another question, ” How can I find the right stock and buy

them with out the assistance of a stock broker?” In the following information I will take

you through the process of finding hot stock picks and turning them into tremendous

profits. Eventually you will even develop a trading system.

First of all lets get the basic steps down before we move to the more advanced

steps. The two main ways to make money in the stock market is from dived ends and

buying low and selling high. To make great outrageous profits you will have to riley on

buying low and selling high. This is very easy to say but very difficult to do. With dived

ends you will receive a small percentage gain every quarter of the year, this helps with

your profits but not much. To buy low and sell high you first have to find some stocks or

funds. With this information and your motivation with stocks you can rule the world!

O.K. maybe not the world but definitely your own portfolio.

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Now that you have the main concepts down we can move on and try to find some

hot stocks. You never want to buy over bought stocks, because over bought stocks

means that they are over valued. If you bought a over valued stock chances are that you

bought high, and this may force you into selling low and take a loss. An easy way to get a

round about feel for a stock to see if it is over or under valued is to look at its PE ratio. To

calculate a PE ratio you take the price per share and divide it by the earnings per share

and this will give you the PE ratio. Most of the time you don’t even have to find out the

p.e. ratio because It will be calculated before hand , so all you have to do is look at it.

Many analysts like PE ratios under 60 or so, but it depends on the industry PE ratio also

( another figure that is pre calculated) (Frailey ,50). This is one of the most important

figures of a stock. Try to avoid buying stocks with high PE ratios for long term holdings,

even if it’s a good company. For example Cisco Systems is a fantastic company, it has

split nine times in the last ten years, it has never disappointed Wall Street with earnings but

with a PE ratio of 125 this stock is over valued. I would buy this stock at about fifty

dollars a share with a PE ratio of about 60. Even the best companies get over valued.

Buy stocks like Cisco on short term pull backs and sell them when they become over

valued.

It is important to develop some type of trading system that will protect your

capital and extend your gains. I do not think there is one trading system out there that

will apply to every stock, so what you must do is modify other systems and develop your

own ( “cut and paste” ). The “pyramid system” is the most practical and useful trading

system in the world. In this particular system you start off with about ten or so individual

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stocks that you think will do very well. There is no way around it, some stock will go up

and some go down, face it. In this particular system you will sell your stocks that decline

by ten percent. Now that you have liquidated some of your stocks you must have a place

to put the money. You will then put that money into your stocks that are going up.

Typically the stocks that start to do well will continue to do so and the ones that do bad will

also continue (Snell 4). You now have started your pyramid system. Selling your stocks

is one of the most difficult things to do and often trading systems do not hold the correct

answers to the question of when to sell your stock. This is where the modification comes

in to play. If you followed this system you would sell when your stock declined by ten

percent. This is a good time to sell if something fundamentally went wrong with the

company, but if your stock was over sold it would have been a bad time to sell. For

example, if you bought into Digital Equipment just before Compaq announced they were

going to buy them out, you would have lost about ten percent. If you followed the

trading system you would have sold and accepted a loss of ten percent. If you had

realized that this particular stock was being over sold because this announcement was really

nothing to worry about you would have held on to the stock. Well as a result of being

over sold the stock shot up almost 100 percent in the next month, alone (Shimo 44).

To find these sold great companies you have to know what to look for in a stock.

I believe that good companies will buy their own stock, so I like to look at the percentage

of institutional shareholders of a company before I buy”(Sheimo 26). When a company

announces a stock buy back plan it often gives the stock a boost because it attracts other

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buyers as well as the employees of the company. A low PE ratio is always nice to see

when looking for a stock to buy because it can mean that this particular stock has more

room to the upside than a stock with a high PE ratio. When a stock has good earnings it

will typically perform well through out the positive earning announcements. If you stay

with the stocks that have good earnings it will lower your risk of loosing your capital and

increase your chances of expanding your gains. If a stock has had a real nice

performance in the last few quarters there is a chance that the stock might split. When a

stock splits 2-for-1 the price is cut in half and the amount of shares you own will double.

A stock split is almost all the time positive for stocks because this will often attract new

buyers into the stock (Sheimo 89). When stocks get upgraded from brokerage firms with

target prices to go along with them you will often find a sharp price run up. Some

brokerage firms often project the company’s earnings for the next year or so and this is a

nice figure to go buy when researching for new stocks. A 25 percent of growth in a

company is a nice growth percentage to see in a years time and it would make for a nice

core holding in any portfolio.

Now that you know what to look for in a stock lets learn about what is good to

avoid in a stock. I become some what nervous when dealing with high PE ratio stocks

for long term holdings. Stay away from stocks with PE ratios in the triple digits, it seems

like it can be very easy to get burnt from these stocks especially on the long term aspect. I

try to avoid stocks without earnings, but if there is profitability in the near future and

revenue is strong I probably would not let that stand in my way of buying a stock.

“Never buy a cheap stock just because it is cheap” (Sheimo 75), this is one mistake many

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beginning investors make. Just because you find a cheap stock does not mean that it is a

good value. When looking for penny stocks you must do more research that just looking

at the price, treat it as you would treat any other stock. “Avoid heavy positions in thinly traded

stocks”(Sheimo 103). A thinly traded stock is considered to be a stock that has a volume of

10,000 or less a day. If you have stocks that are thinly traded there is a possibility that they

might not trade every day and this might cause you to be forced to delay a sell and increase your

losses in that particular stock. Be very careful when dealing with penny stocks, they are

extremely volatile especially thinly traded stocks.

If you have a serious interest in the stock market consider trading your own stocks and

save a little bit of money. Remember the most basic rule buy low and sell high. To effectively

use this very simple rule you must not panic, but you must spend endless time researching and

looking for the next big stock while its still small. Never forget the basic rules of investing,

because those rules are the rules that make the difference between the losers and the winners.

Never follow a trading system to the point where you never consider exceptions and special

situations. It is a good idea to research different trading systems to get a good feel of how to

trade stocks on your own. Research a lot of different stocks and apply the basic rules of the

stock market.

Frailey, Fred. “The King of Wired Investing.” Kiplingers. April 2000: 50-51.

Sheimo, Michael. Stock Market Rules. New York: McGraw-Hill, 1999.

Snell, JR. “How To Uncover and Trade Winning Stocks.” Trader’s Depot. Available:

9 April 2000