Investment Approaches, Strategies and Recommendations

Momentum investing relies on anticipating trends in prices and volumes and is a form of technical analysis. The difference is that the investor will buy stocks which have an upward momentum, assuming it will follow this trajectory. This type of investor also believes they have a better understanding of these ‘hot stocks’ and can time an entry point and exit point to maximize returns. The driver behind momentum stocks is the psychology of the crowd and the timing of the trades.

This is generally a strategy employed by short to medium term investors; however some long term investors also try to use this method.

Buy and hold is a long term investment strategy, which theorizes that fluctuations or declines in the market will be evened out in the long run, and the financial markets will provide a good rate of return. This contrasts the day trading strategy which is based on the concept that profits can be made from trading on the peaks and troughs of the price, within a day (or week). This strategy suits investors who are very conservative and want few hassles from managing their portfolio. Also, brokerage is kept to a minimum.

A common finance theory is the efficient market hypothesis. This states that if every security is valued fairly at all times, then there is no point in trading. The only time you would trade is when you need the money. This theory proves that the buy and hold strategy is the most effective. These theories are good for understanding investment strategies, however as a beginner, it is important to learn why investors act the way they do.

This strategy also minimizes the time you spend watching and evaluating the performance. The types of stocks you purchase for the buy and hold investment strategy will pay dividends regularly, thus providing a steady flow of income, in addition to the capital returns which are realised if you sell. Although these stocks are usually blue chip, a good investor will keep their eye on the underlying performance and ensure that things are not going wrong. Complacency is a danger, as the investor will not be able to react to adverse events if unaware of them.

Top-down investing begins with global economics, both international and national indicators such as GDP growth rates, inflation, interest rates, exchange rates, employment rates, productivity rate sand commodity prices. They then they drill down to more specific information, such as regional and industry analysis which include the size of the market, price levels and the effect of foreign competition and barriers to entry. After this type of analysis, the analyst will look at the business itself to establish a value and compare this to the current market price.

Bottom-up investing starts with specific businesses, regardless of their industry/region. You might have noticed this is the opposite of top down investing. The premise behind this approach is that company’s fundamentals are the most important driver of value, and that economic trends are difficult to decipher. The aim is to look at financial stability, market position and the management in the company, to establish if it is a good company to buy despite the economic conditions at the time.

Growth investing a method of investing in a class of stocks which grow faster than other stocks. During the dot com boom, technology shares were invested in heavily by all types of investors, as the growth of these companies was exponential. The growth investor looks for young companies, which are often pioneers in their field. They typically trade at relatively high prices compared to their earnings, reflecting the expected growth rates. With this, share prices are usually more volatile than average, dividends are either low or non existent (due to reinvestment of profits in the business for further growth).

Value investing involves using some form of bottom up fundamental analysis to establish if shares are underpriced in the market. This can take the form of price-to-earnings ratios, dividend yields or price-to-book ratios. This long term investing approach focuses on the underlying business.

The basics behind this theory are that investors believe there is an underlying worth or “intrinsic value” which is linked to the performance of the underlying business. Using all the information on the company available, an estimate of the value is undertaken. This is then compared to the share price. Since this is an estimate of the value, there needs to be a “margin of safety”, which is the second important concept. This margin ensures that if you get things wrong, you still have a buffer in your estimate.

A famous proponent of this form of investing is Warren Buffet, who said he likes to find outstanding companies at sensible prices.