Investing Styles

So with the above cautions in mind let’s determine what style fits you the best:

A Value Investor buys stocks in good companies that are currently under priced for some short-term reason. These are typically long term investors with a cautious and tax friendly approach to buying stocks. Being tax friendly means not buying and selling stocks frequently causing the payments of capital gains taxes. You pay no tax on the rise of a stock’s price until you sell the stock. Warren Buffett, the second richest man in the world is the classic value investor. In early 2005 Buffett began buying oil and gas pipelines in the U.S. when their price had fallen quite a bit. By 2006 his investment has paid off handsomely. A value investor has to do their homework and be able to buy on bad news.

A Momentum Investor only buys stocks that are going up at the moment, ideally with a large volume of trades per day. They are the surfers of the market who are riding with the herd and are hoping to jump off at the top of the wave. It really doesn’t matter to much which industry or market segment the particular stock is in. The only criteria is that the stock is moving up. By its nature momentum investing is short term and carries a high to moderate degree of risk. The major tip to this type of investing is to remember that stocks fall in price much faster than the rise. Coincidentally this fact is primarily caused by momentum investors all selling at the same time on any hint of bad news.

A Long Term Passive Investor should have a balanced portfolio of growth stocks, dividend paying stocks, some foreign stock exposure along with some investment grade bonds. Depending on your age a different mix of stocks and bonds is called for. About 70% stocks and 30% bonds for a 35 year old is a good starting point. As you age more bond exposure for income is appropriate. Your portfolio should be examined and re-balanced every 6 months at the maximum. Quarterly updates would be more prudent. Mutual funds are a favorite and a wise investment vehicle for this type of investor.

A No Risk Investor should only be in U.S. government notes, bills or bonds and hold them until maturity or in government insured bank certificates of deposit (CD’s) or in actual cash. Although these investments might lose value over time because of inflation their actual dollar amount will not change. You might have $1,000 safely invested in 30 year U.S. Treasury bonds but a thousand bucks will not have the purchasing power it does now in 30 years time. So basically you need to take some risk just to stay even! To be risk free U.S. government bonds you must hold them until maturity. The buying and selling of these bonds is as risky as trading stocks.

A Short Seller is a person who is hoping a stock price will fall. During your research you will come across a stock that seems outrageously over-priced. One whose priced has spiked very high because of some wonderful news. This stock is a candidate to be sold short. If you have a margin account (one that lets you borrow money) you can borrow 100 shares stock and sell it at that very high price. Hopefully, later on reality sets in and the shares drop back in price. You then buy the shares back at the reduced price. You keep the difference between the price sold and the price bought. It is the sell now, buy later plan. Short sellers are the ultimate Bears, cheering all bad news and predicting doom whenever you speak to them.

A Day Trader is interested in being market for only hours or minutes at a time. They might ride the momentum of a stock going up for the day, or pick a low priced stock like Lucent (LU) which selling in the $3 range currently. A lazy day trader of LU might buy 3,000 shares in the morning at $2.95 per share. Then set a limit order to sell if the price reaches $3.01 any time during the day. Go take a nap. If the limit order fills he made $180 while snoozing. Day trading with limit orders is a lot like fishing with a bobber. An aggressive day trader will watch the market and play it like a video game. Buying and selling with just the small fluctuations in the daily price. Some folks have a knack for this and the only way to find out is to give it a try by “paper trading”. That is, setting up a fake portfolio on your My Yahoo page and keep track of your profits and losses in a spreadsheet. No risk, lots of fun and a great educational to boot. Jim Cramer’s Mad Money show on CNBC has become a favorite of active traders. His Lightening Round segment features a rapid-fire call in with instant buy or sell recommendations. Also a lot of fun, but a little over the top with the antics.

A Buy and Hold Investor is the exact opposite of a day trader. This type of investor attempts to find good solid companies and holds their stock through thick and thin with the thought that over time the company will grow into a giant. Well, the old saying that “Trees don’t grow to the sky” applies here as much as it did during the stock market bubble. A buy and hold strategy isn’t the safe thing it sounds to be. In the 1960’s there was a group of stocks called the Nifty 50. They included the likes of General Electric (GE), Coca-Cola (KO) but also included the stocks of Polaroid and Xerox (XRX) which have declined dramatically. Recently in 1999 XRX dropped from near $60 per share to about $5 per share. In my opinion anyway, buy and hold is a very risky strategy.

A Sector Investor specializes in one or two industries such as oil companies or airlines. By tracking and studying one industry you can become familiar with the circumstances that make prices rise and fall. Playing one industry off another is a common strategy as well. For example, if the price of oil is rising it is good for oil companies but bad for airlines that need to buy the fuel. A sector investor has to be ready to pull the sell trigger whenever the fundamentals of his particular industry come under pressure. The buy and hold strategy doesn’t work well with sectors as all industries go through cycles. The airlines are an extreme example because since the Wright brothers the industry has posted a net loss.

BOND Trader

But what makes interest rates go up or down? It’s the economy. When the economy is doing badly the Federal Reserve (sometimes called just The Fed) will lower interest rates to stimulate growth. When the economy is growing at what they consider to be too fast they raise interest rates to dampen growth. If the economy is growing too fast there is a risk of consumer prices going up and that is called inflation. The fundamental role of the Federal Reserve is to control inflation.

So essentially that makes bond traders love bad news. They are basically bearish on the whole world. Why? Because if the economy is slow and life is becoming more miserable interest rates are likely to fall to stimulate some growth. Remember, falling interest rates make the price of their measly bonds go up!