When you're ready to start investing and/or trading the first thing you will need to do is open an account. The first step is to decide on a brokerage firm. There are three different levels of brokerage firms.
Full-service brokers
Discount brokers
Online brokers
Full-service brokers charge higher commissions, but offer more services. They are the preferred broker for people who don't have the time or the desire to do their own research and place their own trades.
Discount brokers charge lower commissions, but have fewer services to offer. They do not offer personalized investing advice. They are preferred by people that like to do their own research and place their own trades.
Online brokers are similar to discount brokers except they offer no brick and mortar locations (Web access only).
Next you will need to decide on what type of account you want to open. Here are a few types of accounts:
Cash
Cash & Margin
Cash, Margin & Option
Cash Account: This is the most common account. Securities (Stocks, ETFs, and Mutual Funds) must be paid in full at time of purchase.
Cash & Margin: To trade on margin you have to request margin approval. The broker will lend you a portion of the purchase price. The loan is collateralized by the securities and cash. If the value of the stock drops by a pre-determined amount, you will be asked to deposit more cash or sell a portion of the stock.
Cash, Margin & Option: To trade options you have to request options approval. Options strategies will also require margin. An option contract is a financial derivative bought by one party (option holder) and sold by another party (option writer). Completing an options agreement will require more information than for a cash account.
Here are the typical questions on most options agreements:
Years of investment experience
Years of options experience
Funds available for options trading
Average transaction size
Number of transactions per year
Types of transactions (Stocks, Options, etc.)
What are your investment objectives? (Note: If you want to trade options, speculation should be one of the boxes you check.)
What type of activity do you plan to conduct in your options account? (Note: Check all boxes, i.e. buy options, write covered options, create spreads, write uncovered options, etc.)
Most brokers will not allow options trading in an IRA (Individual Retirement Account), but there are some brokers that will allow it. Uncovered options strategies are not allowed in an IRA.
Attitude and Risk Tolerance
Successful investors/traders must have a positive attitude and a strong will to succeed. When learning to invest it is easy to get discouraged and quit. Most successful investors/traders have had multiple failures along the way. I don't want that to happen to you! This article was created to give you an edge that most people didn't have when they started investing.
To be successful, you must have:
The right education
The right tools
The right attitude
If you have already been struggling in the stock market, go back and reexamine your prior trades and identify the problem area. One of the biggest mistakes new traders make is risking money they can't afford to lose. They invest car payment money or rent money in the stock market, hoping they will double the money in a matter of hours to days...solving all financial problems. This crosses the line into gambling not investing.
The stock market has a proven track record of being a good place to invest money over the long term. The biggest enemy for most investors is emotion. When stocks are losing value and emotions kick in it's hard to make good decisions. Being indecisive and doing nothing is the worst possible thing to do. Managing risk in a trade helps take the emotion out of investing.
Understanding that getting into a good stock doesn't happen by accident. It takes research and patience to find good company's to invest in.
To determine your risk tolerance, which in turn will determine your trading style ask yourself the following questions:
How much am I willing to lose on any one trade without becoming emotional?
Do I feel more comfortable buying and holding stocks for only short periods of time or do I like to buy and hold stocks for the long-term?
Are the fundamentals of a stock or the chart of a stock more important to me?
Do I like taking risk?
Can I respond to news on my stocks if it impacts the chart or fundamentals?
Matching strategies with your personality and trading style is extremely important. You must identify your strengths and weaknesses in order to develop your trading style around them.
Mutual Funds
Mutual funds are the most commonly known investment vehicle. A mutual fund is made up of a pool of funds for the purpose of investing in securities (stocks, bonds, money market, etc.). Money managers operate the funds and invest the funds capital to produce capital gains and income for investors. The money managers must structure and maintain the portfolio to match the investment objectives outlined in the prospectus.
Mutual funds give small investors access to professionally managed and diversified portfolios. Each shareholder participates proportionally in the gain or loss of the fund.
Disadvantages of mutual funds:
They do not trade like a stock
Brokers charge higher commissions to buy and sell
May have front or back load fees
Front-end load fees are paid to brokers, financial planners, and investment advisors as sales commissions upon initial purchase of a fund. These fees are not included in a funds operating expense.
Back-end load fees are paid to brokers, financial planners, and investment advisors as sales commissions upon selling a fund. The fee is a percentage of the value of the share being sold and the fee decreases yearly until the specified holding period ends, at which time it drops to zero. These fees are also not included in the funds operating expense.
No-load funds do not have front-end and back-end fees. Research shows that funds that charge loads do not necessarily outperform no-load funds.
ETFs
Exchange-traded funds (ETFs) also known as index tracking stocks like mutual funds are a basket of stocks. There is an ETF for almost every sector of the market and for most countries.
Advantages of ETFs:
Trade just like a stock
Diversified like mutual funds
Commissions are the same as on a stock trade
Ability to buy on margin, sell short, and many have options available
Setting Goals
You need to have goals and objectives. Treat investing like a business and set annual goals. Prior to the beginning of each year document your goals and objectives. Write down the percentage return you want to earn for that given year. Depending on the duration of the investment the percentage will vary. Be sure your goals are realistic and you take in consideration that the market average annual returns over the long-term are 10-12% annually.
Goal ideas:
Never lose more than 50% on a option
Never lose more than 10% on a stock
10% annual return this year in my IRA
20% annual return this year in my trading account
Be more patient with my trades
Spend 1 hour a week researching the stocks that I want to invest in
Develop and apply money management rules
Learn how to trade options
Keep 20% of my account in cash for new investment and/or trade ideas
Fundamental Analysis
We will use fundamental analysis to determine if a stock is a quality investment and should be in our portfolio.
Due to article guidelines, we will use company XYZ for our stock and Yahoo finance will be used for our research.
Go to http://finance.yahoo.com/ and enter your favorite stock symbol and click on "Get Quotes" so you can follow along.
Price Pattern
Look at a 1 year chart and a 5 year chart on XYZ. Is the stock in an uptrend, sideways trend or downtrend?
Grade scale: Uptrend (pass), Sideways (neutral), Downtrend (fail)
Answer: Uptrend
Grade: Pass
Analyst Opinion
Yahoo left navigation bar heading - Analyst Opinion
Then look for Recommendation Summary - Mean recommendation (this week).
Note: (Strong buy) 1.0-5.0 (Sell)...The lower the number the better.
Grade scale: 1.0-2.5 (excellent), 2.6-3.0 (good), 3.1-5.0 (bad)
(XYZ) Mean Recommendation (this week): 1.9
Grade: Excellent
Return on Equity
Yahoo left navigation bar heading - Key Statistics
Return on Equity (ROE) is a measure of the return on shareholders equity over the past 12 months...The higher the number the better. For the ROE benchmark, use the S&P 500 average of 14%.
Grade scale: 15% and higher (excellent), 12% to 14.9% (good), 11.9% and lower (bad)
(XYZ) Return on Equity: 22.74%
Grade: Excellent
Current Ratio
Yahoo left navigation bar heading - Key Statistics
The current ratio measures a company's liquidity (its ability to meet its short-term cash flow requirements).
Current ratios below 1.0 can be a warning sign of trouble ahead for the company, since this indicates the company's current liabilities exceed the company's current assets.
Grade scale: 1.5 and higher (excellent), 1.4-1.0 (good), less than 1.0 (bad)
Current Ratio = Current Assets divided by Current Liabilities
(XYZ) Current Ratio: 2.111
Grade: Excellent
Price/Earnings Ratio
Yahoo left navigation bar heading - Key Statistics
Trailing Price/earnings (P/E) ratio is the most commonly used valuation measure. High P/E ratios indicate high expectations for earnings in the future. Growth stocks typically have a higher P/E ratio. Since the P/E will vary by industry group, you should compare the P/E to its peers in the same industry group.
Grade scale: Leads Peers, In-line with Peers, Lags Peers
P/E = current price of the stock divided by earnings per share
(XYZ) Trailing P/E: 29.41
Grade: Leads Peers
Price-To-Earnings Growth
Yahoo left navigation bar heading - Key Statistics
The price-to-earnings growth (PEG) ratio determines how the current stock price compares to projected earnings growth. It's favored by many over P/E because it accounts for growth. A lower number is usually better and may indicate the stock is undervalued, but investors accept higher valuations if the projected growth rate is higher as is the growth rate in most technology companies. Since the PEG ratio will vary by industry group, you should compare the PEG ratio to its peers in the same industry group.
PEG = P/E ratio divided by projected 5-year growth rate
(XYZ) PEG Ratio: 1.67
Grade: Leads Peers
Earnings Per Share
Yahoo left navigation bar heading - Key Statistics
Earnings per share (EPS) is the amount of a company's profit allocated to each outstanding share of common stock. The higher the number the better, though most companies can't sustain these high numbers over the long-term. Compare this value to other companies in the same industry. Values are expressed in dollar terms.
EPS = Net Income minus Dividends on Preferred Stock divided by Average Outstanding Shares
(XYZ) Diluted EPS: 5.72
Grade: Leads Peers
News
Yahoo left navigation bar heading - Headlines
News changes everything. Always browse through the headlines over the last couple of weeks. If there is a negative news story on the stock and the market reacted to it in a negative way, then the grade will be "Fail". Otherwise the stock will receive a "Pass".
Note: Anytime a news story comes out on a company and it is being investigated for accounting issues...
SELL THE STOCK ASAP!
Grade: Pass
Fundamental Analysis Worksheet (XYZ)
Symbol: XYZ
Price Pattern: Pass
Analyst Opinion: Excellent
ROE: Excellent
Current Ratio: Excellent
P/E: Leads Peers
PEG: Leads Peers
EPS: Leads Peers
News: Pass Analysis
Results: Excellent Investment
You now know how to use Yahoo Finance to do a fundamental analysis on your stocks. You can now use the worksheet above to find good quality companies to invest in.
The stocks you invest in don't all have to be "Excellent" and "Leads Peers", but they should have grades of at least "Good" and "In-line with Peers".
Don't invest in stocks that "Fail" the Price Pattern test and/or News test.
Stocks with Analyst Opinion of "Excellent" (1.0-2.5) should outperform over time.
Money Management
Money management is critical in being successful in the market. Many consider it more important than stock picking.
Capital preservation should be your number one priority, profitability second.
Note: Only about 20% of Mutual Fund managers actually beat the S&P 500.
The following are some key points in money management:
Don't buy your entire position in a stock all at the same time. Try to scale in and out of your positions, taking profits alone the way. If you are buying a core holding in your portfolio and your entire position will be 100 shares try buying in blocks of 25 shares. Buy your first 25 shares and then wait for a pullback in the stock of 3.5% to buy your next 25 shares. If the stock never pulls back that far before you reach your profit target...don't worry be happy...take the money and run. You will have to decide what's an acceptable profit target for you. You might consider 10%-15% as a starting point...don't be greedy.
Take losses quickly and let your profits run. Most investors want to continue to hold on to their losers and sell their winners to make up for it. Everyone has losers and you should accept that. You must set a stop loss, typically this is 8-10%. If a stock goes down 8-10% from your buy price cut your losses short and sell it. This is the only way to ensure that you will not have huge damaging losses in your portfolio. On the other side of the coin it is key to let your winners/profits run. If you have a stock that is doing well take some profits along the way, but let the rest of your shares run.
Maintain appropriate position sizing. Maintaining appropriate position sizing will protect you from allowing one bad trade or investment to have too large of an impact on your account. Position sizing is the number of stock shares or option contracts you buy/sell in any one trade or stock investment. For investments consider not having anymore than 5-10% of your portfolio value in any one stock. For trades consider not risking more than 2-3% of your portfolio value in any one trade. Reduce the percentages significantly in a bear market.
Document your trades and investments. This should include why you're entering/exiting a trade or investment. Keeping records will help you duplicate your successful trades/investments and avoid unsuccessful ones in the future.
I hope that you found the information in this article useful and are able to begin applying the "Fundamental Analysis Worksheet".
Copyright © 2009, InvestSharp Trading, LLC. All rights reserved.
Randy Smotone is the editor and founder of InvestSharp Trading, LLC. InvestSharp strives to provide self-directed investors and traders with all the tools and information needed to be successful in today's market. If you would like to learn more about InvestSharp, please visit our website at http://www.investsharp.com.
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