Steps for Investment Strategy for Stock Market - Essay Example

1.Introduction 2 1.1.Thesis of the paper 2 2.Strategic steps in Investments in Stock Market 3 2.1.Internal Analysis and Development of Specific Objective 4 2.2.External analysis for Stock/Company selection 4 2.2.1.Macroeconomic Analysis 5 2.2.2.Data Collection 5 2.2.3.Fundamental Analysis 5 2.2.4.Technical Analysis 6 2.3.Estimation of Intrinsic Value and Buy-Hold-Sell Strategy 6 2.4.Framing of Strategic Portfolio (diversification) 7 2.5.Monitor and Manage Portfolio based on Market Condition 8 2.6.Pre-return and Post-return Evaluation 9 3.Conclusion 9 3.1.Suggestion 9 Reference 11 1. Introduction The emergence of the capital market is one of the most prominent developments in the field of financial activities. The capital markets play a very pertinent role in the economic development and this market is very necessary for publicly listed companies as well as for the investors. The capital market is a crucial platform, where a company issues shares and raises capital and besides, the institutional and individual investors buy those stocks in order to make higher return on their investments. It has been empirically proved that the return on stock been the higher than any other investments and on the other hand, stock market is also very risky comparing to other alternative investments. As capital market is very volatile and requires very efficient and effective strategies for making investments in stock market. The stock markets are highly uncertain, and it is difficult to predict. Therefore, the chances of loss are higher without proper investment plan (Aït-Sahalia and Hansen, 2009, p.619). 1.1. Thesis of the paper This paper will attempt to present an argumentative discussion on the investment strategy for a stock market. In regard to trading strategies in stock market, many have argued against the stock investment by claiming it as a zero sum game as there are equal number of winners and losers (White, 2003, p.85). Stock market is highly volatile and to take a winners’ position is quite challenging. An efficient trading strategy can make gains in bullish as well as in bearish market. The following figure presents volatility of the FTSE for the last forty years. Figure 1: -Standard Deviation of Monthly FTSE Stock Returns from Daily Returns in the Month, 1969-2010 (Source: Schwert, 2011, p.27) The above figure clearly indicates high volatile nature of the stock market which acts as negative force against investors seeking high returns from their investments. 2. Strategic steps in Investments in Stock Market The most of investors who faced great loses due to investments in the stock market is mainly caused by their lack of knowledge and lack of general awareness. In fact, many investors having very limited knowledge regarding stock investments tend to face loses from the stock market investments and their investment behavior mainly driven by behavioral finance. The investors often make investment based on their behavior which in mainly driven by unconventional market behavior. For example, investors should buy a stock when it comes to its lower boundary and sells just before it is supposed to fall (Baker and Nofsinger, 2010, p.43). However, generally, investors do the opposite and face losses. However, there are also certain factors that must be taken into consideration, and the entire investment should follow a systematic steps. These steps are given below for making at least 40% return on investment from the stock market by the end of next two year at lowest risk level i.e. minimum standard deviation. 2.1. Internal Analysis and Development of Specific Objective Investor seeking to make investment in the stock market, the first task for them should be to analyze the internal factors that affect the risk tolerance and available fund for making investment in stock market. The risk tolerance factors are age, income & wealth level, family background & condition etc. The investors must go for this internal analysis to understand their risk tolerance level. Based on this analysis, the investors should determine the required return on investment, as according to financial theory, higher risk leads to higher return and vice versa (Wilson, 2008, p.25-27). Finally, the objective of investment can be framed in accordance to outcome of internal analysis and objective must be specific and measurable. The specific objective of this paper in to earn 40% return from stock investment within 2 years with a portfolio having minimum standard deviation. 2.2. External analysis for Stock/Company selection After determining the specific objective, it is necessary to select favorable stocks of companies that will be expected to offer 40% return by the next two years. The selection process requires extensive analyses that should include macroeconomic analysis, data collection, fundamental and technical analysis. 2.2.1. Macroeconomic Analysis The prime objective of macroeconomic analysis is to select the specific sectors in which investment can be made that will offer 40% return with lower risk level. Besides, the macroeconomic analysis will also help to understand the viability of the economy for stock investment. In this respect, it is necessary to analyze the economic cycle of the entire economy and the industry cycles for a number of growing sectors. The sectors may include financial, energy, retail, health care, IT etc. The reason behind selecting a number of sectors is to diversify the risk, and hence, it is necessary to invest more than one industry and companies. 2.2.2. Data Collection The second task in external analysis after determining the preferable sectors for making stock investments is to collect the data for fundamental and technical analysis. The data includes the information regarding the companies that belong to those selected sectors. The data should be obtained from the secondary sources like annual report of the companies, recent market news of any development or negative news, reports of popular analysts, historical price movements of stock or related news like stock-splits, dividends etc. 2.2.3. Fundamental Analysis The fundamental analysis is considered to be the best method for determining the investment strategy. The fundamental analysis is generally conducted on the basis of the historical data for the company. The fundamental analysis is an exhaustive study of the company that aims to determine its future growth as well as the growth of its stock. The fundamental analysis using the secondary data should include qualitative and quantitative. It has been empirically proved that stock performance is highly driven by the factors like management performance, recent development, prevailing financial strength of the company, historical dividends etc. In order to evaluate the performance of these factors, certain financial techniques can be used like financial statement and stock analysis using financial ratios. Besides, it using fundamental analysis, it is possible to compute the expected rate of return from each stock using the techniques like dividend growth model, CAPM model etc. If any investor is unaware of these techniques, they can avail readymade reports prepared by reliable and efficient research analysts (Liu and Zhang, 2010, p.8). 2.2.4. Technical Analysis Like the fundamental analysis, the technical analysis also requires the historical data but it only considers the historical prices. As per the assumption of technical analysis, it is believed that each stock has its own specific movement which is supposed to repeat, and thus, the future movements of stock can be determined. Technical analysis entirely relies on the different types of graphs and charts (Ni, 2006, p.24). To Frame the different graphs and charts of different stock requires technical skills and specific professional software. However, technical charts can also be available from many online sources like websites of stocks exchanges, or other financial websites like Bloomberg, Reuters etc. 2.3. Estimation of Intrinsic Value and Buy-Hold-Sell Strategy Apart from determining the forecasted price of the stock prices, it is also necessary to estimate the intrinsic value of a stock. The intrinsic value of a stock implies the actual value of the stock in accordance to the company performance. The analysis of intrinsic value is very necessary for making the buy-hold-Sell strategy as per the market condition. It helps to indentify that whether the stock is overvalued, undervalued or perfectly valued, and accordingly, investors should sell, buy and hold respectively (Chechile, 2004, p.207). 2.4. Framing of Strategic Portfolio (diversification) Once the investors is through with the assessment of intrinsic value, it is necessary to buy the stock of the different sectors that will aim to offer the 40% return by the end of second years at minimum level risk. In this regard, it is necessary to consider the aggressive stock having greater return records. However, these stocks are also highly risky. Moreover, it should also be kept in mind that stock markets cannot be predictive and therefore, risk should be diversified. In this regard, correlation and regression analysis will be helpful. The portfolio must include stock having negative correlation but these companies’ stock should be undervalued (Lovins, 2002, p.158). The following figure gives a general idea of sector wise correlation consideration in selecting stocks. (Source: RBC Direct Investing Inc, 2011) 2.5. Monitor and Manage Portfolio based on Market Condition After following the above steps, a portfolio is framed that consists of different types of assets. The investments must be made as per ranks of the stocks and the weights should also be determined accordingly. The stocks must be ranked as per their risk and return category and their prevailing intrinsic value. Thus, an efficient portfolio or stocks can be made. However, once the portfolio is framed, it is also necessary to monitor it regularly based on the market news. The prices of each stock will move upwards or downwards and investors must act accordingly for selling and buying new stocks. For example, in case of an overvalued stock, investors must sell those stocks and buy undervalued stocks (Jones, 2007, p.488-490). 2.6. Pre-return and Post-return Evaluation Along with in the monitoring the portfolio, it is also necessary to keep constant evaluation of the portfolio using financial and statistical techniques. In this process, the primary technique is by calculating the return on total investments that must be compared with the pre-determined benchmark e.g. in this case, the benchmark is the 40% return at minimal risk level. Besides, there are also certain financial methods like Sharp Ratio, Treynor Ratio etc, and the statistical techniques like SD, calculation of alpha and beta etc. These techniques mainly measure the effectiveness of the investments strategy. Finally, at the end, to evaluate overall performance of portfolio, the average return on the investment should be calculated and it must be adjusted with the buying and selling activities that have been made during the last two years (Allison, 2010). 3. Conclusion The primary aim of this paper is to support the argument that by making investments in stock market a return of 40% can be achieved by following strategic steps of the entire investment activity. Hence, this paper has presented five significant steps for achieving 40% of the profit within next two years and each step has been explained by offering techniques valuable for investments strategy which focus to increase risks at minimal level or risks. 3.1. Suggestion The above stated steps for making investment in stock market are efficient to achieve the specific investment objective. However, there are also certain factors that must take into consideration in the entire process of managing the investment. Firstly, the time is the most crucial factor and investment must take necessary action in proper time. For example, investors must do the activities of buy-hold-sell in a timely manner so that effectiveness of portfolio cannot be hurt. Secondly, the investor should be engaged in constant buying and selling activities with the market movements, and it is necessary to reinvest the gains made from trading activities by including other growth oriented stock in the portfolio. The new ranges of stock must be chosen as per investment goals and objective. Thirdly, the investors must keep themselves up-to-date regarding the market news of companies whose stocks have been included in the portfolio and, moreover, they also need to constantly look for better stocks though proper stock analysis. Reference Aït-Sahalia, Y. and Hansen, A. P. (2009). Handbook of financial econometrics: Tools and techniques. Elsevier. Allison, D. (August 16, 2010). 4 Steps to Creating A Better Investment Strategy. Retrieved on July 9, 2011 from http://www.investopedia.com/articles/trading/10/creating-a-better-investment-strategy.asp#axzz1RaPkwJHw. Baker, H. K. and Nofsinger, J. R. (2010). Behavioral Finance: Investors, Corporations, and Markets. John Wiley and Sons. Chechile, R. A. (2004). The ABCs of IPOs: Investment Strategies and Tactics for New Issue Securities. iUniverse. Jones, C. P. (2007). Investments: Analysis and Management. 9th ed. Wiley-India. Liu and Zhang, (April 26, 2010). Stock Market Simulation. Retrieved on July 9, 2011 from http://www.wpi.edu/Pubs/E-project/Available/E-project-042510-205700/unrestricted/DZT0906_IQP_Report.pdf. Lovins, A. B. (2002). Small is profitable. Earthscan. Ni, M. Y. (August 2006). Stock Market Trading. Retrieved on July 9, 2011 from http://www.wpi.edu/Pubs/E-project/Available/E-project-082106-140345/unrestricted/0517_Final.pdf. RBC Direct Investing Inc. (2011). Stock Selection Strategies. Retrieved on July 9, 2011 from https://www6.royalbank.com/educationcentre/english/equities/stock-selection-strategies.html. Schwert, G. W. (April 2011). Stock Volatility during the Recent Financial Crisis. Retrieved on July 9, 2011 from http://www.nber.org/papers/w16976.pdf. White, J. (2003). Investing in Stocks and Shares: A Step-by-step Guide to Making Money on the Stock Market. 6th ed. How To Books Ltd. Wilson, T. M. (2008). The Effects of Gender, Age, Education, and Risk Tolerance on Credit Card Balances. 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