Your Questions About How To Pick Stocks To Buy

Sandra asks…

Is investing money in stocks during a recession a good idea?

I mean, if the idea is to buy low and sell high, wouldn’t you want to jump on when the DJIA is low, because eventually it’s just going to go back up again?

John answers:

Buying during Jan 1975 was a very good idea, but buying during June 1974 was not such a good idea. You have to pick the right time during the recession, preferrably towards the end.

Lisa asks…

How do i be not embarrassed to buy a sex toy?

I’m 24 yr old male. I wanna experiment with some stuff, but i think it’d be kinda embarrassing to go into a sex store to buy a dildo. How do you get over that?

John answers:

You could buy it all over the internet if you prefer but if you really want to go into a sex store (it’s a little thrill in itself) then go somewhere out of town where you know you won’t bump into anyone who knows you.

Try to find a good one though, pick the biggest, brightest one you can find rather than some crappy little back-alley place. Don’t feel nervous about buying any sex toy, to the people who work there it’s just stock to be sold and all the other customers in the store are there for the same reason as you.

Michael asks…

What are some good stocks on the NASDAQ or NYSE to invest in?

I am doing a stock market simulation in my english class and I really want to do well. What are some good stocks on the NASDAQ or NYSE to invest in? I can only buy stocks on the NASDAQ or NYSE. It doesn’t matter how much the stock costs as long as it will go up.

John answers:

Well, you have to realize that it could go up or it could go down. In general there may be a true value for that company and as long as the company is making a profit, that value should be be rising if he profits are reinvested to grow the business or the profit would be distributed through dividends, often both, but no one really know what that value is and the stock price are the speculation by investors of what that value may be. If you assume that investors are rational and competent ( a big if ) then the stock price could go up or it could go down but the overall expectation of the investment should be positive if it’s a good business model and the company hasn’t taken on too many risks.

So how do you make money if the stock can go up or down? Well, if you model an investment by a random walk, what is often called in physics, brownian motion, then it could go up or down equally. With a random walk you would balance it with uncorrelated investments usually bonds. Claude Shannon at MIT showed that the optimal growth of an investment balanced between a random walk and cash is 50/50. For example, a $1,000 portfolio between a stock ( random walk ) and cash would start at $500 / $500, if the stock should drop in half, you would have $250 / $500 so you would rebalance by buying $125 in stock to give you $375 / $375. If the stock should return to it’s original price you would have $750 / $375 for a portfolio value of $1,125 even though the stock has essentially been unchanged. If the stock had doubled and then halved, you would also have $1,125. So balancing your portfolio essentially buys low and sells high.

Then there’s the issue of how much to invest and how much to diversify. John Kelly took Claude Shannon’s Information theory and applied it to gambling in what’s known as the Kelly Criterion. Imagine if you had a coin toss where if you won, you won twice your wager plus the return of your wager but lost your wager when you loosed. It’s a positive expectation game, you would expect to gain $1.50 for every $1 you lost. If you risk nothing by betting nothing, you win nothing, the more you bet, the more you win but if you bet everything that you have, you will lose everything with the first loss. So how does a positive sure win opportunity become a total loss? It turns out if you bet more than 50% of your portfolio, you will lose everything. If you bet 25%, you will gain the most over multiple bets. Now if you could bet on on two such coin tosses at the same time, the optimal is 21% per coin toss for a total of 42% of your portfolio. So the more you diversify between uncorrelated investments, the more you can safely invest. Of course investments are never really uncorrelated or as easy to calculate as a coin toss.

Warren Buffet says you only have to diversify 6 times if you know what you’re doing, most value investment books say to diversify 30 times. If you look at the portfolios of mutual funds, the top holdings are all about 2% of the portfolio. This is because on the Kelly Criterion, you’re safer if you come in low of the Criterion then when you come in high and in stocks, you have very little idea where that criterion is.

So pick good companies with good businesses, diversify and rebalance. Keep a little bit in bonds just in case they all tank.

Trying to pick just one that will “go up” is basically betting on a horse in a horse race.

David asks…

Why is it that when stock prices go down, people immediately sell their stocks?

Is it possible for you to just keep the stocks and wait for the price to go up before selling? Or do you really have to sell it immediately?

John answers:

This is a great question, one that’s asked frequently and never resolved as it’s up to you personally as a stock investor to make the decision.

Share prices go up and down as a matter of day to day buying and selling, but when a significant drop happens you need to find out exactly why. Has there been a significant drop in the stock market overall or has a critical event happened only involving only one stock? What are the chances of the company or sector recovering and how long are you prepared to wait?

As a stock trader or investor you have a number of options when a price suddenly drops:
1. Sell at a loss and take what you have left.
2. Hold the stock and wait for a potential recovery.
3. Average down and buy more stock at the lower price in order to increase your exposure with the expectation that the stock price will correct itself. (Risky Move)

Many stock traders use bad news as indicators to buy into a stock at the lowest possible price hoping to pick up a “bargain”.

Let me use BP as an example. On 20 April 2010 the Deepwater Horizon Oil Spill occurred. BP’s stock price went from $60.57 to $29.20. That’s a negative 52% in 50 days. Today, BP is opening at $36.88. Most responsible investors would have used a stop order aka stop limit at around the $55.00 mark (10%) and got out then and there. However if you decided to hold the stock and panicked when it went below $30.00 you’d now be short $6.88 a share

Ultimately the answer to your question is no. You do not have to sell any of your stocks when the price drops and sometimes it pays off to simply hold on for the long term. The only exception to this rule is if you’ve bought the stocks using a margin loan in which you can be forced to sell or top up your margin account with cash. Personally I would never buy stocks without placing a stop-loss at around the 10% mark, especially for a large company such as BP. This would protect me against these “sudden drops” as well as giving me the option to buy back in when the dust (or oil in this case) settles.

Good luck to you, the trading climate is hard out there at the moment. Keep an eye out for bargains though, they’re out there if you look hard enough.

John asks…

Is there any way to get a set amount taken out of my bank account every week to buy stocks?

I’d like to open an account that would take $50 or so out of my checking account every week and use it to buy stocks that I have picked. I could do it manually, but if I had to pay $7 or $8 bucks a week in fees, then it wouldn’t be worth it.

John answers:

There are mutual funds that have automatic investment options very similar to what you are describing. They do not do it on a weekly basis but on a monthly basis–very close. T Rowe Price is one fund company that will allow that, and there are no purchase fees.

Http://individual.troweprice.com/public/Retail/Planning-&-Research/Tools-&-Resources/Investment-Planning/Automatic-Asset-Builder

Other mutual funds also have these type plans. I think this is your best option for automatic investment.

If you do not mind doing the manual labor, some companies do allow direct purchase of their stock with no fees. There generally is a minimum on the first purchase of about $500, but subsequent purchases are in the range of $50 and you can purchase fractional shares so that you can do $50 each time. Not every company allows this only some. Here is a link to the list. This list also includes dividend re-investment so you need to note the “plan type”.

Http://www.amstock.com/investpower/new_plandet2.asp

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