Monday, March 29, 2010

Learn Stock Market Investing Basics

Investors "buy and hold", traders "buy and sell". While that may be overly simplistic, it's essentially how it works. So, what's up with trading? Why does it seem so alluring, and can you really make any decent money doing it?

For the most part, and for most people, the answer is "No". The only people who make a consistent profit trading stocks, rather than practicing investing strategies, are those who treat it as a business and have the time, skills, discipline, and resources that are necessary to be a successful at trader. Most everyone else fails. Stock market investing, on the other hand, contains a built-in goal: "Invest".

Although the market often trends down for days, weeks, months, and sometimes even years, the overall direction of the stock market has always been up, and it is likely to continue in that direction unless something very scary happens in the world.

While traders try to "time" the market by selling stocks when they think that the market has peaked, and buying back when the trend starts to reverse, it really isn't that easy to predict. As a result, billions of dollars are lost each year by market "timers" who got it wrong.

One old but relevant study examined the returns for the Standard & Poor's 500 between 1926 and 1987. This study found that the S&P 500 returned, on average, about 9.44% during the 62 years from 1926 through the end of 1987. But that wasn't the interesting part.

What was really telling happened when they looked at the market return on a month-by-month basis. In the 744 months comprising those 62 years, nearly 100% of the overall increase in the market occurred in just 50 months!

Imagine being a stock trader and trying to time the market in that scenario. If you missed just 50 of the best performing months out of the 744 months, your average annual return would have been 0%!

Another thing that they discovered was that most of each year's gain usually happened in just one of the 12 months each year. Analysis showed that the market gained an average of 8.68% during the best performing month in each of the 62 years. On the other side of the equation, the market advanced just 0.76% during the other 11 months of each year.

Investor would have been immune to all of this. Traders, however, had 12:1 odds AGAINST timing the market moves correctly each year during the study period!


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