10 rules before investing in the stock market

How to invest in the stock market?

If you are considering to become an investor in the stock market, you should check these 10 main rules:

1º Never use credit

The stock market has, by itself, enought risk already. The maximum loss you can take in stocks is all the investment made. If you use a loan, in the worst case cenario you end up in a negative position instead of zero, plus interest to keep paying. It will become riskier and you might have to sell stocks at a bad timing in order to honor your credit conditions.

You should only use a certain amount of your savings.

2º Always have liquidity 

An investor should only use savings to invest, however, first you have to garantee you have enought liquidity.

And by enought liquidity, I mean you have to have enought money in your account that assures you will not have to sell any stocks to face unexpected expenses. I would recommend first to have six months of liquidity in your account and only then you should start saving and investing in the stock market.

3º Always diversify

Basic and one of the most important rule of how to invest in the stock market – DIVERSIFY!

When investing, the best way to reduce your portfolio risk is to diversify.

Always remember to “Never put all the eggs in the same basket”.

You should look for stocks in different sectors, different industries and even differents stock markets and pick your companies wisely.

4º Set your target

Why are you investing? Are you investing to assure retirement? Or your kids education? Or simply just to make more money in he stock market?

These are the type of questions you have to make to yourself and then set up your target.

A financial advisor can help you in this process and is highly recommended, but that doesn’t mean you don’t study and do your own research, i recommend you to learn and read some books about the stock market that teach you how to invest, like The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) (Collins Business Essentials), and available in kindle The Intelligent Investor, Rev. Ed (Collins Business Essentials).

5º Know your stocks

Before you start investing in the stock market, you must define your asset allocation, you must study and do some stock market research, prepare a check list to screen for stocks, look at their financial ratios and know it’s fair value. To learn more, Finance for Executives: Managing for Value Creation is a must read, and available in kindle version Finance for Executives: Managing for Value Creation.

6º Make a plan

Define an investment strategy, the asset allocation and its proportion, compatible with your target and your risk tolerance, in order to achieve the best return with the minimum risk. Planning makes all the diference and it’s important to do it properly.

To learn more about how to invest in the stock market and making an efficient portfolio Modern Portfolio Theory and Investment Analysis is a must read, available in kindle version Modern Portfolio Theory and Investment Analysis, 9th Edition.

7º Envolve your family

If you are married and you have a family, you should discuss and plan together, adjusting your target and portfolio risk to the couple risk tolerance.

8º Follow your plan

In the short term, market does a “random walk”, and only in the long term it is possible to take conclusions about your portfolio and see if you are reaching your target.

And if you don’t follow your plan, you will never be able to say it works or that your strategy needs some adjustments.

Avoid doing this

 

9º Performance evaluation and adjustments

After a certain period of time, you should evaluate your portfolio performance and compare it with the benchmark (if you are investing in the American stock market, you should compare your portfolio performance with the S&P 500, for example). One way to compare performance is using the Sharpe ratio,

Sharpe ratio = (portfolio return – risk free) / portfolio volatility

Then you should adjust your plan if necessary and rebalance your portfolio.

10º Emotions out

Very important if you are investing in the stock market, be rational, protect your portfolio from your emotions.

When you have your money “on the line” it’s easy to lose control and rush to a bad decision.

News do not help either.

You must focus on your target and always follow your plan.

“…That would come as a positive surprise to the markets and reverse their mood – and markets do have moods; that is what the authorities have to learn.”

Soros, G. Financial Times online. 25/01/2012

Remember, keep calm, keep it simple and invest

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António Ramos

Financial Analyst

(CEFA holder)

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Back to the basics

Like in any project you may embrace in life, you should always have a good “know how” about it.

Investing in the stock market it is not diferent, you should never put your money in something that you do not understand.

About the stock market: 

Companies can finance their activities by asking loans, issuing bonds and equity.

Equity is part of the companies ownership. If you buy stocks of a certain company, you become her owner (in the same relative amount).

A publicly trade company goes to the market and sells part of her equity in order to finance her activity.

Therefore, when you are buying stocks you are making an investment in the long run (I am excluding traders), and you should expected return in the same time frame.

And when I mention expected return, I must also mention risk. Both are connected and for more return in your portfolio you should always expect more risk in it.

And, because it is an investment for a long period of time, you should select your stock (company) wisely.

You should look for a company with a good perspective of growth, analize the risk, and for that you must understand the financial ratios. Then you should buy it below it’s fair value price (often investors use market corrections to do so).

Risk is present in everything you do in life, including the stock market investments.

If you are buying a stock from a company that goes bankrupt, you can lose all the money invested. However, if you have done your research properly and DIVERSIFIED, you can reduce the risk of your portfolio and obtain a good return.

“Never put all your eggs in the same basket”, always diversify. Diversify by sectors, industry and geografic regions.

One final thing about investing in the stock market: make a plan, your plan.

Set your target (you can be investing for retirement, for your kids education, and so on…)

Set your investment estrategy.

Execute your plan and adjuste it when necessary.

And never let emotion interfere. News are full of traps.

Keep calm and invest.

Share if you liked it.

António Ramos

Financial Anayst

(CEFA holder)

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I hope you enjoy and participate.

Regards,

António Ramos

Financial Analyst (CEFA holder)

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