The implications of the theories of the stock markets on investers
Many investors use formula plans such as dollar-cost averaging to
avoid having to time the markets. These plans eliminate the need for
timing the markets, although investors still need to choose the stocks
to buy and sell using these plans. By buying shares of stocks over a
specified period at different prices, investors lessen the effect of price
fluctuations. Bear in mind that if the markets plummet, these methods
do not result in investors not losing money. These methods keep
investors in the markets whether the market is going up or down.
You can find formula plans and investment strategies for buying
and selling stocks, but no “magic” plan for beating the market
exists. Some investment strategies have produced returns superior
to those earned by the stock market as a whole over various periods.
However, over long periods, consistently beating the market
becomes exceedingly difficult.
Investors still need to decide which stocks to invest in and
when to buy and sell. Fundamental analysis provides insight into
the makeup of a company and its industry, which may be helpful
in the selection of stocks for the long term. Technical analysis uses
past price and volume information as well as charting to determine
when to buy and sell stocks. The efficient market hypothesis renders
technical analysis a waste of time because, according to the
hypothesis, past stock prices reflect all available information.
Therefore, the movements of past stock prices have no relationships
to future prices. The relationship between past and future stock
prices reflects the weak form of the efficient market hypothesis. The
semistrong form suggests that no undervalued or overvalued
stocks exist because all public information is reflected in the stock
prices, which is a kick in the teeth to fundamental analysts. The
strong form implies that the markets are perfect. They have digested
all information pertaining to a stock’s value.
Little evidence exists to support the strong form. But some
contradictions of the semistrong form suggest that the market has
inefficiencies, particularly with regard to small stocks that have
been ignored by fundamental analysts. After all, it is the fundamental
analysts, in competition with one another, who make the
markets more efficient, which lends support for the semistrong
The CAPM differentiates the risk in the portfolio into two parts:
systematic and unsystematic risk. A diversified portfolio of stocks
eliminates only unsystematic risk, which leaves the portfolio exposed
to systematic risk. Thus, to earn higher returns in the market, you
have to invest in stocks with higher beta factors (a coefficient
measuring the systematic or market risk) than the market has.
The theories of stock prices and the market are important for
* Investors will not consistently earn superior returns over
those of the stock market for long periods.
* Diversification of a portfolio can reduce the overall risk of
* The way to increase returns is to invest in riskier securities.
However, if the market “heads south,” the riskier securities
decline by more than the averages of the market. Other
studies, such as the one by Fama and French (1992), show
the opposite effect. The lowest-risk securities outperform
the highest-risk securities.
These theories and reasons emphasize the importance of the
construction of a portfolio of investments that is compatible with
an investor’s overall risk comfort level. Diversification can accomplish
this goal and eliminate some risk. Furthermore, investors can
improve returns by holding securities for at least a year to qualify
for the lower capital gains taxes and the reduction of investment
fees and commissions.
Tax planning can reduce taxes and increase returns to some
extent. Long-term capital gains (securities held for longer than one
year that are sold at more than their original purchase price) are
taxed at lower rates than the higher marginal tax rates for ordinary
income and short-term gains (investments held for less than one
year). Capital gains become much more important than ordinary
income for high-tax-bracket investors. Dividends also receive
favorable tax treatment. In the years 2003 through 2008, dividends
will be taxed at lower rates than the marginal-tax-bracket rates.
Reducing or eliminating fees and sales commissions can increase
returns significantly. Because many brokers make their
money by buying and selling securities, they have an incentive to
advise their clients to trade more than they should. This process,
called churning, involves the buying and selling of stocks at a rate
that is not justified by their returns.
Categories in Trading Mistakes
Lack of Trading Plan
Planning plays a key role in the success or failure of any endeavor
Using too much Leverage
Determining the proper capital requirements for trading is a difficult task
Failure to control Risk
Refusing to employ effective risk control measures can ensure your long-term failure
Lack of Discipline
A lack of discipline can destroy even the most talented and best prepared trader
Useful Advices to Beginning Trader
You can control your success or failure
All about Stocks
Encyclopedia about Stocks. That you should know about Stocks before starting
All terms about Forex market