What you need to know before you invest in shares

Shares are one of the greatest investment innovations of our time.

They allow anybody to own a portion of a business or businesses without getting personally involved in day-to-day operations.

And with that ownership comes the opportunity to make money in two main ways: through dividends divided and shared out from business profits, and through capital gains from share price changes.

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But while anyone can buy and sell shares, only a few make money in the stock market. Why? Because many people jump into the market without knowing what style and strategies to use.

The ingredients

Your style of profiting in the stock market is what determines what stocks you buy, at what price, and when you buy and sell the stocks.

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These three (the stock, price and time) are the ingredients you need to get right if you’re to succeed in the stock market.

It’s possible to get the stock right, but buy or sell at the wrong time, or get the stock right, but buy it at too high a price.

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These two scenarios put you at risk of losing your capital.

So, to get it right, you have to decide on a style. Just like your taste determines the types of clothes you buy, your style of dealing in stocks will influence what you buy.

Broadly speaking, there are two styles of profiting from the stock market: investing and trading. Each of these two styles has different off-shoots or sub-styles based on what factors you considers most effective in bringing returns.

You need to know and decide what style suits you because each has its strategies, and entry or exit criteria.

The chances of succeeding are higher when you have the discipline to stick to your style.

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Investing styles are generally long term, and are more concerned with the fundamentals of the business behind the stock.

The smart investor

Issues of profitability, durability and sustainability of the business are of great importance to the smart investor.

Some of the important indicators of business growth that you would monitor as an investor are sales, earnings, equity, cash flow and return on invested capital.

Investing styles revolve around three key metrics of performance: dividend growth, value growth and earnings growth rates. These styles are dubbed income investing, value investing and growth investing, respectively.

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Income investing: This is an investing style whose strategy involves investing in companies that have a history of giving dividends. Because investors are sure of the dividend being given, they rely on this as a source of regular income.

Value investing: This strategy involves investing in companies that have been undervalued by the market. Positions are held until the market realises its mistake and values them correctly.

Growth investing: This strategy involves investing in companies that have high-growth potential; that is, they have an expected earnings growth that is higher than that of other companies in the same industry, or the market as a whole.

Trading styles are generally short and medium term in nature, and are more concerned with the market dynamics of supply and demand, sentiments and crowd psychology.

These aspects of the market are best captured on charts, with the most basic ones being those of price and volume. It’s important for a trader, and even an investor, to know how to read these charts because they help in timing entry and exit.

In reference to trading styles, you will generally hear of day trading, swing trading or position trading.

Day trading is a trading style in which positions are held for just one day in an attempt to capture intra-day market moves. 

Swing trading is a trading style in which positions are held for a period of days, weeks or even months in an attempt to capture short-term market moves.

Position trading encompasses the longest trading time frame. Positions generally span a period of months to years. Traders using this style exploit a combination of technical and fundamental analyses to make trading decisions.

So, before you jump into the market, examine these styles and their attendant strategies and see which one suits your beliefs, personality and circumstances.

Without knowing your style, you’re likely to be confused and, in the process, lose money. Your style and your strategy are the road-maps to success in stocks. You can get more information on the different styles from the Internet, relevant books or experts.

The writer is the author of The Ultimate Framework for Success in Shares.

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Nairobi Securities ExchangeSharesGeoffrey Odundo