Stock Market 101

Stock Market Basics

The stock market is a fine way of losing money ! Take it from one who knows. Back in 2000 when the dotcom bubble went ' pop ' we were told that dotcoms were a waste of space and that we should never have invested in them and that it served us right for thinking we could get rich quick from stock trading.

The right thing to do and the thing that the 'experts' were doing was to invest in solid blue chip companies that were making a profit and that paid dividends. Companies like Bank of America, AIG, Lehmans. Bear Sterns, Royal Bank of Scotland, Barclays Bank, USB, etc...

That turned out to be nonsense too, as all of them lost between 90% and 100% of their value and if you had any money invested in them then you were well and truly stuffed! Your investments lost as much as the dotcom rubbish.

Except that since the bottom of the markets back in March 2009 when the S&P famously bottomed out at 666, the markets have turned around and gone back up. So you only lost your money if you sold out at the bottom, or if you gave it all to Bernie Madoff. Those who held their nerve have made their money back and more, as the stock markets are now at all time highs again!

As Warren Buffett says - "the stock market is a means for transferring money from the impatient to the patient"! That's easy to say of course if you can afford to ride out the storm, and it's worth bearing in mind that a lot of small investors lost a lot of money back in 2008 and 2009 as they couldn't afford to sit tight and see their savings disappear.

Even legendary investor Warren Buffet lost over $20 billion dollars in a year - that takes some doing for the smartest investor on the planet. He also admitted that he made some mistakes back in 2008, like buying unnamed Irish banks that lost 83% of their value.

The moral of the story is that no-one knows what they're doing - the stock market is according to some basically a giant Ponzi scheme which works as long as it works and no-one finds out that the emperor has no clothes, but once things start to fall apart it is like the famous domino theory the USA was so worried about in Vietnam back in the '60s. One domino fell and brought down all the others. Or as Warren Buffett puts it "when the tide goes out you find out who is wearing no shorts". Since the crash the stock market has been held up by the FED printing money in the form of quantitative easing. The economy has still not recovered, and it will be interesting to see what happens when the FED does finally stop printing money and starts raising interest rates again, which will probably happen in early 2015.

Back in 2008, as the dominoes fell they first revealed the incompetents and then the crooks like Bernie Madoff and Allen Stanford (allegedly) and others. The crooks have caused a lot of people to lose a lot of money but they did not cause the crisis and they are a mere drop in the ocean of the trillions that have disappeared.

Where are the Stock Markets Headed?

So what next ? The DOW fell from over 14,000 to under 7,000 in just over a year, but then started an almighty bounce, much to the surprise of many!

One person who gets his predictions right more than he gets them wrong is Oscar at Live With Oscar - he puts his videos up on youtube for everyone to see free of charge. He was been negative starting in October 2007, but became bullish again back in 2009 and is currently still bullish, despite markets being at their all time highs.

Because the stock market is a great way of losing money it is also a great way of making money, and when it turned it turned out to be an excellent opportunity for some people (mainly professional investors) to make some serious money. Timing is everything of course !

The DOW turned in March 2009 and has not looked back since! But at some point it will, so take care !

The golden rule of course is not to invest what you can't afford to lose. Trying to second guess the markets is notoriously difficult for amateur investors and traders. So another golden rule is to have a stop loss! A stop loss is a point at which you automatically sell your investments if they fall by a certain amount (this applies to traders rather than to long-term investors). The amount most people set their stop losses at is around 5%. So if the stocks you have bought fall back 5% from their high point, or the point at which you bought them, then you should sell up and look for something else! You have a lost a battle but not the war!

It is important to understand that you can't get it right all the time. Some of your traders will turn out to be mistakes and you need to accept this fact and cut your losses. When trading stocks, traders try to limit their losses on any single trade to around 4 or 5% and try to make around 10% on any winning trade. By doing this they are controlling their risk/reward ratio. To many people make the mistake of hanging on to their losers, despite the evidence that is staring them in the face, in the hope of making back the money they have lost on the same share! It is a better idea to try and make back the money you have lost on a different share! One that is going up not down!

So that is why traders will cut their losses and move on to another trade.

This only applies to traders, however, who use charts to try and time their trades. Long-term investors are much less interested in charts, as they base their investment decisions on 'fundamentals' i.e. how sound a company is and how good its profits are etc... this is what Warren Buffett does, but it does involve a lot of work and a good understanding of company accounts (and of course a certain amount of trust in the honesty of these accounts).