Smart Investing Starts With You-Here’s How
So, Mr. CBB asked me to do a series here on an introduction to investing after the success of my Investing 101 for Newbies post that I recently shared. I thought that would be a pretty good idea because I don’t cover that too much on my financial insight blog. I’ve decided to split this series into three main components, with smaller components along the way as I deem necessary. The series will get more and more specific as I go along.
- The Basic Terminology
- Basic Investment Strategies
- Risk Management
These are the three essentials that every new investor must be familiar with. If you don’t know the basic lingo, it’s like walking around blind. So to take off that blindfold, in this post I’ll be talking about basic investment jargon (investment terms) so at least you know what the news anchor on CNBC is talking about.
Position size is the portion of your portfolio that a certain investment takes up. For example, let’s assume that you have $100,000. If you have $30,000 invested in stock A, then your position size for stock A is 30%. Position size can never exceed 100%.
Why is position size so important? Different types of investors have different purposes for it.
The buy and hold investor will look at position size as the prime way to diversify his holdings (portfolio). Based upon the “don’t put all your eggs in one basket” adage, he/she will not want any position size to be too large (e.g. in excess of 40%).
After all, if one egg “breaks”, a large position size will severely damage one’s portfolio. But if each of your individual positions sizes are small, one stock “blowing up” will not hurt your overall investment performance too badly.
On the other hand, more active investors, traders, and fund managers will use position size as a way to control risk. It’s often said that execution is more important than your market prediction, and position size is one of the biggest components of that “execution”. Let’s not go into more detail on this for now, but we will touch on it later.
The two terms, bullish or bearish, are the financial lingo for up or down. Being bullish means that you expect prices will go up.
There are different types of bullishness, defined by the time frame. Some people will be bullish on the intermediate term, meaning that they expect prices will rise in the short-term. On the other hand, long-term bullish investors will expect prices to rise on average in the next 5, 10, or 15 years. Of course, long-term bullish investors expect prices will fall sometimes, but on the grand picture, long-term bullish investors expect the price to be much higher in the future than today.
Bullish investors primarily express their market outlook by buying securities, whether that be stocks, bonds, currencies, commodities, etc.
Being bearish is exactly the opposite of being bullish. When you’re bearish, you expect prices to decline. Like bullish investors, bearish investors are split based upon their time frames. Intermediate “bears” expect prices to decline in the short-term, whereas long-term bears (the doom-and-gloomers) expect prices to decline in the long run.
Expressing a bearish prediction on the market is more complex than expressing a bullish prediction. “Bears” can short a stock (betting on its decline), buy put options, or buy short-ETF’s. We’ll get more into these strategies in later posts.
Market corrections are when prices temporarily change from their “normal” direction.
If the predominating trend in the market is UP (e.g. if prices have risen in the past 6 months), then a market correction will be when prices fall a bit. However, in order for falling prices to be labelled a “market correction” the market must RESUME it’s upwards trend very soon (or else it would be called a market peak).
Similarly, if the market has been falling for a long time, a market correction will be when prices temporarily go up (but soon resume their down-trend). Market corrections are critical to investors, all depending on how you use them. Most investors use market corrections as a way to get in the market at a cheaper price. Let’s assume that an investor is bullish and he wants to buy stock A.
Instead of “chasing the rising market” and buying into his position when prices are expensive, he might wait for the market to correct itself so that he can buy at a cheaper price.
Market corrections are also known as pullbacks.
Trends are a very important concept, especially if you’re a trend follower.
Trends are the dominant direction that markets are going. If the market has risen for the past couple of months, then the market’s trend is UP. If the market has fallen, then the trend is DOWN.
Trends are very important, because a lot of trend followers assume that trends will extend themselves (which is often true). If the market has been going down for the past couple of months, then I might assume that the down-trend will continue (hence I will continue to be bearish). If the market has been going up, then I might be bullish and expect prices to rise even more. Of course, the key here is to predict when the trend will end (which we will cover in later posts).
Please come back next week for the next installment of An Introduction to Investing – Part Two.
Contribution by: Troy not only blogs at The Financial Economist, he also started a new blog called Technical Indicators Guy. He created two separate blogs because his first focuses on financial insight whereas his second focuses on technical indicators (for different audiences).
Editors Note: Thanks Troy for sharing this educational information with the fans and I today. Although some of my fans may be very knowledgeable when it comes to investing others like me are just learning the ropes. Your introduction to investment series will help give us a better idea of the basic terminology that any investor should know.
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