Buying Stocks 101

Investors looking for alternatives to the stock market, either because of downward trends, stagnant growth, or the pace of trading, often find themselves investigating the wild and wooly world of forex trading.  Once the realm of large banks and global corporations, the forex (foreign exchange) market is now the playground of a wide range of entities and investors; some seasoned and skilled, others new and naive.  Forex Investing is a bit of a misnomer.  It would be more appropriate to say forex trading, because unlike the stock market where you buy and sell assets which have value in dollars, on the forex market, the asset IS the dollar, or other currency you may hold.  So Forex Investing could be simplified to say investing in currency, or currencies; essentially trading forms of money.  While it doesn’t carry the complexities of buying stocks, it does have its own language, strategies, and risks, which should be understood well before the first trade is made.

The Market

When you choose to dive into the world of forex investing, you may find the market to be a bit different than you are used to.  Unlike stocks, where you have central trading locations called stock exchanges, forex trading is done mainly through electronic trading networks or by phone.  The largest market for currencies is called the “Interbank Market”, and is dominated by large financial institutions and multi-national corporations.  In contrast to buying stocks, where the market has defined trading hours, forex markets are open 24 hours a day.

Order Types

When trading foreign currencies, you have many options on what type of trade order you want to initiate.  Beyond just buy and sell, these order types allow you exercise some control over your trades and manage risk in a very volatile environment.  If you just want to buy or sell at the current market price, that is known as a Market Order.  If you would rather trade a specific price, that would be a Limit Order.  If you want to prevent catastrophic loses, you may want to initiate a Stop-Loss Order at a specific price level.  If you believe the market is going to go up or down and want to enter the market then, a Limit Entry Order is for you.  If you believe the market is going to continue in the same direction as it is currently, you might want to issue a Stop Entry Order.  The beauty of Forex investing comes in when you combine these order types and use things like OCO orders to work a strategy.  OCO Orders, or one-cancels-the-other orders, allow you to set up multiple orders and cancel one of the other is executed.  GTC, or good-til-cancelled, orders are often used in conjunction with OCO orders since these orders stay in the market until they are filled or cancelled.

Types of Trades

As in buying stocks, you have long and short trade positions.  If you are long, you are attempting the profit from an increase in the price of the currency, essentially implementing a buy-low, sell-high strategy.  If you are short, you think the price will decrease, and are attempting to sell-high.

Trading Strategies

Forex investing comes with its own unique trading strategies, where the serious forex investor might use a combination of these strategies to hedge against the inherent market risk while realizing a solid profit.  As with other markets, you have strategies based around Technical Analysis where analyzing charts and trends helps the investor predict the ebbs and flows of the market.  In contrast, Fundamental Analysis studies the macro-economic indicators that are the basis for the underlying value of the currency.  Trend trading attempts to ride waves or movements in the price of a currency.  Swing Trading deals with trading according to short to medium term trends.  Range trading attempts to find the upper and lower bounds of a currency, using a combination of analytical models, in order to trade the currency inside of the range.  News Trading bases trades on news headlines and media reports.  Scalping strategies deal with making very small gains on very short term trades, taking advantage of minute fluctuations in the market.  Day trading is similar, except the trade periods can last longer, minutes or hours.  A strategy which attempts to profit in the fluctuations of interest rates is called Carry Trading.  A style of trading that involves buying and holding a currency for a longer period of time is called Position Trading.

Training

As you can see Forex Investing goes much deeper than just exchanging one currency for another, and is a whole different animal than buying stocks or bonds.  It is vital that the investor fully understand the world of currency trading before risking even moderate sums of money in the market.  It is advisable that the novice Forex investor take a course on forex investing or at least become familiar with some of the trading strategies via an online product like Forex Rebellion. Time, practice, and patience are essential for success with Forex Investments.

Sometimes the world of investing can seem daunting.  Covered calls, put options, derivatives, commodity futures: it often feels like a PH.D. is required just to play the game.  But the truth of the matter is that most of that stuff doesn’t matter.  Well, it matters a little, but not as much as the foundation of investing since the first corporation was born - trading shares of stock for profit.  People often get sidetracked by the hot new investment strategy that the money shows are promoting this week, but that is often driven more by ratings and viewership than by time-proven investment strategy.  Buying stocks low and selling them for a healthy gain is not a fad - it is the essence of investing.

But how does one identify a good stock to buy?

Value Investing

Before so many alternative investment methods took the stage, the core principle preached to the masses was invest for value.  That is the principle that Warren Buffet used to amass his fortune, and it is one that you should apply to your portfolio before any other.  Value investing simply means to look for stocks that are performing better than their peers in key areas, such as earnings and sales, but is trading lower than the value of the company and its assets.  Essentially, you want to trade shares of stock that are undervalued, meaning the stock price is lower than what the company fundamentals suggest it should be.  You are buying stocks at bargain prices, and reaping the gains as the market begins to recognize their true worth.

Is the Company Healthy?

Even if the stock looks like a good buy, you still need to go over the company fundamentals to make sure its healthy.  The companies public financial documents, press releases, and other data help you formulate a picture of the companies health.  The price-to-earnings ratio is a key indicator as to the value of the stock, and whether the company is trading high or low compared to what it is bringing in.  The industry the company serves, it’s current market position, and the general prospect of the products it sells are also import factors to consider.  Many people trade shares without understanding the data behind them to their detriment.

How is it Positioned?

Also important are more esoteric factors like how the company is positioned in the marketplace and how strong its brand is at the moment.  Does the company occupy a niche that is serves better than anyone else?  Is it well-established?  How hard is it for another company to enter the market?  Are they putting any money into research and development?  If you were buying a business, you would certainly consider these questions.  Why should it be any different when buying stocks?

Who’s Investing in it?

This one is a bit more difficult to discover but it is vital none-the-less.  You can find a great stock that meets all of the points we have already covered, and it take years before it makes you any real money.  Why?  Because other people aren’t buying it also.  You may have discovered a gem before many other people did, that’s great!  But you eventually want people to discover it so they can drive the price up, making you money.  How can you trade shares of stock for profit if no one is trading that stock but you?  That is a bit of an over-simplification, but you get the point.  Check to see if mutual funds or pension plans are starting to buy that stock.  Look for write ups in newsletters or market analysts beginning to highlight its value.  This is tricky because you don’t want to buy too early, but you also don’t want to buy too late.  You want to ride the wave as it’s building not as it’s about to crest or before you are sure it will actually turn into a wave.