Market fluctuation is the reason people believe that investing in stocks is risky and should be avoided altogether.
You dream of investing profitably in stocks, but are afraid of incurring losses from a fall in stock prices.
Why market fluctuations impact the stock market
The stock market consists of many different participants, from retail investors with a small capital to fund managers with billions of investment funds. Each has different reasons for buying stocks.
Some buy shares to hold for the long-term. Some trade shares for a quick buck in the short run. There are speculators who chase shares to try their luck similar to gambling.
Most traders and speculators do not hold stocks for the long run.
The market works in cycles. There are good and bad times. Both will swing back and forth like a pendulum.
When times are good and income is rising, people are encouraged to take some risk and buy stock.
This will lift stock prices, which helps traders and speculators to buy more shares in search of capital gain.
This explains why stock can be ridiculously overpriced as they are not purchased based on logic but on greed.
When times are bad, institutional investors, especially the ones that need to show short-term results to their clients, may dispose of their stocks.
This causes a fall in stock prices which ignites panic selling. This explains why stock can be ridiculously undervalued because the disposal of shares is not based on logic, but on fear.
How you lose money in the stock market
Most people who lose money in the stock market intended to make capital gains fast from their stock purchases.
They think that the stock market is a place to earn quick money with minimum effort. This is a fallacy.
They buy stock to earn capital gain, not dividend yields. This is because the profits from capital gains are more appealing than dividend yields.
How do they decide that the stock is good? They look at charts. If the stock has risen in price, then it is a good stock as it is moving upwards.
If it is rising, they think it will move higher in the future and purchase the stock.
Now two things can happen. First, it rises further so they feel great as their investment is working.
They will buy more stock at the higher price. This is referred to as “The Greater Fool Theory” for their capital gains are reliant on having more ”‘fools” to buy the same stock at higher prices.
Second, the stock price may fall. Investors who bought shares will either hold as they believe that the price will recover in due time or they will sell their stock to cut their losses.
The odds are not in favour of these speculators, because they tend to buy stocks after the prices went up significantly.
If the price of their stock rises further, they make lesser capital gain compared to those who bought earlier.
If the price of their shares fall, they incur higher losses than those who bought at lower prices.
That is why most traders and speculators do not last long in the stock market.
How to make money in the stock market
Instead of treating shares like lottery tickets, assess the investment potential of each stock as if you are going to be a long-term partner of the company.
True investors are cash-flow orientated. When you analyse a stock, find out its business model, management team, profit track record and cash flow, cash-in-hand and plans to create more profit for the future.
This is step one in stock investing.
Step two is about valuation. The assessment involves calculating Price-to-earnings (P/E) ratio, Price-to-book (P/B) ratio and Dividend Yields and comparing with peers of the same industry.
The aim is to buy good stock when it is undervalued, so, when the price increases, you make more money.
If the stock price declines, you lose less money compared to those who bought at higher prices.
In short, market fluctuations are a friend to investors but an enemy to speculators. Market fluctuations enable you to invest into good businesses at undervalued prices and provide opportunities to dispose of them if they are overpriced.
They enable savvy investors to build long-term wealth and passive income from stock investing.
Investment success requires you to learn, study and master investment skills like accounting and stock valuation.
Most people don’t have the desire or time to learn and practise by themselves, so they should not be investing their money in the stock market.
This article first appeared in kclau.com
Ian Tai is the founder of Bursaking.com.my, a platform that empowers retail investors to build wealth through ownership of fundamentally solid stocks. It is an essential tool that sifts out stocks that grow profits consistently from a database of over 900+ stocks listed mainly in Malaysia.