Editor’s note: This article was first published in October 2011, as a market outlook written during the European debt crisis. Its forecasts that the stock market would not deliver its usual return “this year” or next, the possibility of a new recession and brokers offering up to 10x leverage reflect that time.
The market is volatile and nobody can predict where it’s heading, so at any moment, a piece of bad news could send stock markets tumbling. Given this well-founded uncertainty, the way we should invest in the stock market clearly changes, at least when it comes to avoiding bigger risks. Here are some tips for both beginners and advanced investors.
1. Keep an eye on the macroeconomy
Stock markets are now driven by macroeconomic fear, which wasn’t always the case. Right now, it doesn’t matter whether Inditex has increased its sales or Telefónica has closed new business deals. A simple fear that a European country might collapse can send the Tokyo, London, New York and Madrid stock exchanges plunging. So even if you have your money tied up in a company with good prospects, its share price will fall. You could almost say that these days you don’t invest in a company but in the index itself, and the index moves on the kind of news you need to watch.
The market, and stock investing itself, has become predictable: stocks move according to the early-morning news, so you need to keep up with financial news. It was always this way, but now it’s mandatory.
2. Diversify
When we talk about diversification, we don’t just mean investing in different companies on the stock market, such as bank shares and renewable energy stocks, because, as we said in point 1, in a serious downturn both would fall.
By diversification, we mean investing part of the money you’ve set aside for investing in fixed-income products too, such as bonds or fixed-term deposits, and even corporate debt if you see a good opportunity. While we can’t say for sure that we’ll end up in a new recession, I wouldn’t rule it out, so part of our portfolio should be kept safe (just in case).
3. Use conditional orders
Although I’ve never been a fan of stop losses, I now strongly recommend them. There are different types of stop loss: sell stops, buy stops, trailing stops… Right now, I’d recommend using a sell stop loss to set the loss you’re willing to accept. For those unfamiliar with this type of order, it’s simple to explain.
If you buy a company’s shares at €10 hoping their value will rise, but also worried it might fall, you can place a stop loss at €8. That way, if the share price starts to drop, at least you make sure you won’t lose your money, because at roughly €8 the platform will send an automatic sell order. That’s the theory, anyway; in practice, it doesn’t mean the shares will be sold at exactly €8. It could be at €8.15, or, if there aren’t enough buyers for all the shares at that moment, only 50% may be sold at that price and the rest go below €8. Even so, use this type of order (given what could happen in the current situation).
4. Beware of bargains
I’ll say it again: there are people eager to get into the stock market when they see share prices. It’s true that they’re dirt cheap, and we all like buying cheap. After all, if we had to define the secret of profitable investing, it would be exactly that: buy low and sell high. But right now, if you’re drawn in by a stock that has fallen 40%, you may find that once you’ve bought that bargain, it ends up down 60%. Be very careful with the analysis you do before investing.
5. Long term or short term?
The question of the century. Historically, the stock market has been one of the most profitable investments, delivering an average annual return of 12%. I predict right now that the stock market won’t deliver that return this year, and probably not next year either.
Even though I’m not a fan of trading, the truth is that right now you need to take a short-term position in the stock market, and if you see a striking rally, consider taking profits so you can reinvest on the next drop (because make no mistake, it will fall again). Given the volatility, the market moves in short cycles, where an uptrend isn’t even lasting 72 hours, and 24 hours can wipe out the gains of 15 days. Ideal for using the ball investment system.
If the shares you’ve bought start to plunge, you know you need to turn to one of the three investment strategies for falling stocks, which you should always analyze, as we mentioned, with the macroeconomy in mind.
So I recommend short-term investing, because if things don’t go as you expected, you can turn it into a long-term investment, as long as you didn’t set a stop loss on it.
6. Be careful with investing on credit
I know that right now, platforms are offering very attractive terms for investing on credit, letting you multiply the real money you put in by up to 10 times. So if you go in with €1,000 and come out ahead, you wouldn’t collect gains on €1,000 but on €10,000. This is very tempting, to the point that we forget that if we make losses instead of gains, those are multiplied by 10 too, so not only would you have lost money, you’d also be left in debt. Which brings us to our last basic principle.
7. Now more than ever, don’t invest money you’ll need
When it comes to investing in the stock market, this is advice we’ve always given. Never invest money you might need and/or can’t afford to lose, and certainly never get into the stock market without at least some basic knowledge.
These are some of the tips we can offer. As you’ll notice, we’re working from the possibility that the economic situation gets worse, and this way, at least, we can reduce the risks a little.
Remember that sometimes… “it’s better to be wrong and not win than to be wrong and lose.”
Featured image: Kondo Atsushi, CC BY-SA 2.0, via Wikimedia Commons.
