How you can make money in the share market

There will be risks with any investment decision you make and investing in the share market (the market) is no exception. In reality, investing in the market is one of the riskiest investments you can make. But where there is risk, there is an opportunity for reward. In the market, reward comes in the form of profiting from rising share prices. Unfortunately for most however, the attraction of making a profit overshadows the risks that come with share market investment and the absolute need to have strategies in place to manage them.

Additionally, before investing, you should understand how the market works, you should formulate an investment strategy to suit your requirements, you should do a lot of company research and you should accept there will be price volatility. The unfortunate reality is that most get caught up with the idea of making a profit and these considerations fall by the wayside. As a consequence, they lose money. We all know someone who has lost money in the share market, right?

If you want to maximise your chances of success in the market, follow the five steps below .

Step 1. Analysis: top-down and fundamental

Your analysis is critical to your success. If you get this wrong you could find you invest in the wrong companies.

Top-down analysis will identify which industry sector(s) (e.g. financials, mining, healthcare) offer the best opportunities for investment at the time. You should begin by looking at the global economy and focus on economic indicators, interest rates, GDP growth rates, commodity and energy prices, currencies and exchange rates etc. Once you have analysed this data, you will be able to determine which industry sector(s) are best positioned to benefit from current and forecast conditions.

Next, you can now move on to analysing the financial health of the companies within the sector(s) you have identified. This process is referred to as fundamental analysis. Fundamental analysis generally involves assessing the financial position of the company, the capability of management, looking at their competitors, identifying their opportunities for growth and analysing their products and services and the markets in which they trade.

Your analysis has now narrowed down the entire share market and provided a short list of stocks worthy of investment.

Step 2. Be a contrarian

Now you know which companies to invest in, you need to consider your investment strategy.

A contrarian approach to investing is used by Warren Buffet, the world’s most successful share market investor. Buffet’s philosophy is ‘be greedy when others are fearful, be fearful when others are greedy.’ Adopting a contrarian approach will mean you are buying shares at a time when everyone else is selling. The selling can be triggered for numerous reasons including unfavourable economic data, changes in government policy or company results not meeting analysts expectations.

Whatever the case, often the selling is irrational and without fundamental justification, so the price often recovers once this has been realised. Under these circumstances, the sellers will usually outnumber the buyers causing the price to fall, so you will be able to purchase quality companies at a lower price than before. By doing this, you have effectively become a ‘value’ investor. A value investor seeks out the highest quality companies and purchases them when they are mispriced by the market (i.e. when they are cheaper than they should be).

Step 3. Don’t invest all your money at once

Company share prices fluctuate every day on the market, sometimes significantly. Given this, you need to remember that if you invest all your money at today’s price, you may forgo an opportunity to buy the same company for a cheaper price tomorrow, next week, next month etc. This means you could have made a bigger profit if you’d waited and bought the shares at a lower price. However, it is simply not possible to know when a share has reached its lowest price before it starts to rise. Therefore, it’s very unlikely you will be able to invest all of your money at the bottom price.

So what should you do to buy your shares as cheaply as possible?

You should be patient and disciplined and buy small allocations over time. For example, if you consider a company share price to be good value now and you decide to buy, you might invest 20% of your capital now, then another 20% once the prices drops 3%, then another 20% once the price drops another 3% and so on. This approach might take weeks, months or even years before you become fully invested (if at all). Regardless of this, buying small allocations is a surefire method to maximise your profits and protect your capital if the price declines significantly.

Step 4. Invest directly, don’t use managed funds

Broadly speaking, you can invest in the share market in two ways – via managed funds or directly via a broker. You will get far superior returns if you invest directly, for a number of reasons.

Firstly, managed fund providers charge you a management fee which is deducted from your investment return and the fee is still charged when share prices are declining. This means the management fees can erode your capital in times of market decline. There are no ongoing costs to eat into your profit or capital if you hold shares directly.

Secondly, managed funds are generally fully-invested in the market at all times. They do not time their buys to ensure the best price like you can when you invest directly.

Thirdly, investing directly allows you to manage your tax position. You can implement many strategies to minimise tax when you hold shares directly. This is not possible with managed funds.

Lastly, you have complete control over the price at which you sell your shares when you invest directly. This means you can determine when to take profits and how much profit to take. If you invest via managed funds, it often takes a week or more to withdraw your funds, and the fund manager will simply sell your investment on the day your withdrawal request is processed (i.e. there is no consideration given to the price on the day and therefore no consideration given to your profit objectives).

Step 5. Put a stop loss in place

A stop loss is a pre-determined price (below the market price) at which you will sell your shares if the price begins to decline. For example, you may decide to place a stop loss at 15% below the opening price on a particular day. This means your shares would be sold if the share price dropped more than 15% below the opening price. By doing this, you know that you will not lose more than 15% if the market falls. This strategy effectively protects your profits and is therefore a crucial step to maximising your success in the share market. Without a stop loss, all your hard work can be undone very quickly.

Of course, you may not have the time or interest to invest in the share market applying the steps above, but you may want to profit from rising share prices just the same. In this case, we recommend you protect your capital and maximise your chances of success by engaging the services of an expert.

This advice may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial and tax advice prior to acting on this information.Opinions constitute our judgement at the time of issue and are subject to change. Financial Planning Expert Pty Ltd does not give any warranty of accuracy, nor accept any responsibility for errors or omissions in this document.
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    Financial Planning Expert is an independent financial planning business based in Melbourne. We provide genuinely independent and conflict free financial advice. We’re experts in self-managed superannuation fund (SMSFs) advice and strategy, retirement planning, property and share investment advice, life and income protection insurance, tax planning, asset protection, estate planning and advice for Australian expatriates.