Choosing the right Stock Market vehicle for you

You want to make money in the markets, but a Stock is just not a Stock, and they are not the only way you can make money in the markets.

Just buying stocks at a price and seeing them go up over time is the simplest of methods of investing (or trading). There are many other approaches that you may not be familiar with. Such as Shorting (making money as share prices fall), Options (a derivative of stocks), or simply different types of stocks.

Shares just ain’t Shares!

In the following article, I’m going to touch on each of the different “stock” investments available so you have a basic idea on what they are. I’ll discuss the Risks and Opportunities and sum up with my view on where you can participate at various levels of experience.

The markets have different Vehicles to suit different Investors!

What we see on the news, read in the paper, or discuss with friends and family is probably the basis for most beginners when it comes to their understanding of investing or trading in the markets. Unless you’re talking to someone who has financial experience, you are likely to be given a biased opinion on what they think you should do when it comes to investing.

That’s where someone like me comes into the picture!

I’m an analyst first and foremost. I evaluate the pros and cons of everything, before forming an opinion and then strategizing. Following that, execution and management are the critical steps.

Just buying stocks might not be the most suitable approach for you. It might not meet your needs or goals. But without knowing what you can do in the markets, most people only think about buying stocks. And end up being disillusioned with performance or constantly fearing the risk of a market crash.

So here is a quick run down of some of the key areas where you can participate investing or trading in the markets.

What Stock suits you best?

Ok, so there are actually various categories of stocks. Each is different in potential for return and levels of risk. Knowing the difference can help you avoid situations where you could lose all your capital, or to negate stressing about your invested money.

They key categories we will review are:

  • Blue Chip Stocks
  • Small Caps
  • Penny Stocks/Pink Sheets
  • IPO’s
  • ETF’s

Let’s take a look at each of these different types of Stock investment you might consider.

Blue Chip Stocks

These are the well-established, large companies that we typically think of such as Goldman Sachs, General Electric, Boeing, or BHP Ltd. In many examples, they will pay dividends. But they are also typically less volatile than other categories. They certainly can fall just as quickly when a crash occurs, however their growth is normally dependent on economic and market conditions.

Blue Chip companies will have strong management teams of industry leaders. This suggests better decisions will be made, and therefore, more stability for the company.

Expected Returns: Typically in-line with broader market movements with slow, consistent growth. Long-term average return for the broader market is 10% per annum or 7% per annum adjusted for inflation, which includes Dividends (distribution of company profits to shareholders). Investors expect to make more than this on individual companies, but the long-term average is similar to leading indices.

Risk: Considered “lower Risk” as they have historical performance of consistent earnings growth. Broader economic/market sentiment will influence stock prices.

Volatility: Low. Increases during broader market Corrections/Downtrends.

Analytics: Fundamental and Industry techniques will help establish a ‘view’ for growth potential. Technical Analysis can assist, but is not the primary methodology.

Type of Investor/Trader: Long-term. Beginners to Experienced.

How much effort?: More time is required in researching and analyzing, but less time in managing and trading.

Small Caps.

These are companies that have smaller market value then Blue Chip Stocks. They don’t have strong influence on broader market sentiment, but they can be more volatile. Normally, their stock price is much lower than the blue chips. So investors see this as an opportunity to “buy more stock” with the same amount of money. A small price movement results in bigger gains (percentage wise). But for increased potential return comes increased potential for loss. These companies may have less resources for management and operations, and may also carry more debt than blue chips

Expected Returns: To outperform Blue Chips. This could be anywhere from 30% to hundreds of percent return.

Risk: High. Company, Industry or broader Economic influences can cause price fluctuations

Volatility: Extremes. Small Caps can sit dormant for long periods of time. When positive or negative announcements are made, Volatility can increase instantly.

Analytics: Fundamentals of company and industry can provide a basis for decision-making. Technical Analysis can provide insight into investor sentiment, highlighting build-up of buyers or sellers.

Type of Investor/Trader: Speculative. With the uncertain nature of the smaller companies, there is less historical reference the company can achieve their intended goals. Beginners are attracted to this space more so than Experienced.

How much effort?: Just as much effort is required in reviewing and analyzing as Blue Chips. More effort is required in monitoring and evaluating

Penny Stocks/Pink sheets.

These are smaller companies again. The biggest problem I have is the lack of volume activity. It might be well and good that if you put money down on a Penny stock, a small price movement results in massive gains. But if you can’t sell at the price you want because there are no buyers, then what is the point? There is a high rate of loss in this area, however, those few massive gains can keep the investor/trader active. It can take a long time for a Penny Stock to gain traction in the industry and influence the stock price to rise.

Expected Returns: This space attracts expectations for high returns – hundreds of percent.

Risk: Very High, up to 100%. Most investors in this space lose money on more positions than winners. However, the winners have very high returns.

Volatility: Extremes. Penny stocks can sit dormant for long periods of time. When positive or negative announcements are made, Volatility can increase instantly.

Analytics: Fundamentals of Company and Industry can provide a basis for decision-making. Technical Analysis can provide insight into investor sentiment, highlighting build-up of buyers or sellers.

Type of Investor/Trader: Speculative. With the uncertain nature of Penny Stocks, there is less historical reference the company can achieve their intended goals. Beginners are attracted to this space more so than Experienced.

How much effort?: Just as much effort is required in reviewing and analyzing as Blue Chips. More effort is required in monitoring and evaluating

IPO’s (Initial Public Offerings).

IPO’s are a great way of getting in early. There are many examples of company’s publicly listing on an exchange and seeing the share prices rise (due to demand) early on. But quite often you will find quick price rises followed by sharp declines as the early investors take profit.
Success of an IPO can come down to numerous influences; Demand for IPO’s due to economic influences (strong economies provide higher probability of success); the Investment Bank/Broker promoting the IPO; Investor expectations for company/industry.
Be aware that smaller IPO prices can remain dormant or flat for a very long time.

Expected Returns: This space attracts expectations for high returns – hundreds of percent.

Risk: Very High, up to 100%. Most investors in this space lose money on more positions than winners. However, the winners have very high returns.

Volatility: Extremes. IPO’s can sit dormant for long periods of time. When positive or negative announcements are made, Volatility can increase instantly.

Analytics: Fundamentals of Company and Industry can provide a basis for decision-making. Technical Analysis can provide insight into investor sentiment, highlighting build-up of buyers or sellers.

Type of Investor/Trader: Speculative. With the uncertain nature of IPO’s, there is less historical reference the company can achieve their intended goals. Beginners are attracted to this space more so than Experienced.

How much effort?: Just as much effort is required in reviewing and analyzing as Blue Chips. More effort is required in monitoring and evaluating

ETF’s (Exchange Traded Funds).

Over the last decade, ETF’s have become more popular for longer-term investors and short-term traders alike.
An ETF is an exchange-traded stock. But unlike a company, such as Apple Inc, the shares have no ownership in the company itself. ETF shares give you ownership in a Fund that owns shares/commodities/FX.
So for example, the SPDR S&P500 ETF is a fund that owns shares in the company’s that make up the S&P500 Index (one of the key benchmark indices for the US markets). Instead of you going and buying those shares independently to gain the same exposure, you can buy the one stock (code: SPY).
With so many variations in ETF’s, you can gain exposure in any global market, commodities, currencies, group of stocks, industries, or even “Inverse” ETF’s which make money as stocks go down (See our article on Shorting your way to a Profit).
The trade off is that there is typically less volatility in the underlying prices than stocks themselves. The fund will charge fees, which are absorbed into the share price (not paid directly by you), however, you only have one transaction (brokerage) fee when buying or selling.

Expected Returns: Similar to Blue Chip stocks when considering Index ETF’s. However, greater returns (and therefore risk) can be considered with Industry specific ETF’s. Some Dividends are available amongst ETF’s.

Risk: Again, similar to Blue Chip stocks. However, unlike a stock, an ETF will never “disappear” (delist) from the exchange due to poor performance. Not unless all the represented companies fail. And then, a poor performing company will typically be replaced by a better performing company. So I would consider the Risk to be less than Blue Chips.

Volatility: Same as broader market, but can increase slightly with industry specific ETF’s.

Analytics: Both Fundamentals and Technicals are used in this space. How much fundamental research you do depends on your strategy approach. You could fundamentally analyse the industry/category the ETF represents, or you could drill down into each individual stock. For ETF’s, I like to use simple Fundamental analysis techniques and overlay with a Technical approach for entry.

Type of Investor/Trader: Beginners to Experienced. I find ETF’s to be a great starting point for beginners, but even now I still use them for various portfolio strategies.

How much effort?: Less effort than Blue Chip stocks. Same amount of research/analysis per trade, however, with an ETF you don’t have to review as many stocks. Therefore, a narrower field to start with. Management is the same, dependent on the strategy approach you implement.

What should you choose?

For Beginners, I suggest ETF’s or Blue Chip stocks. The rate of return may not be as high as you are expecting (especially if you have been listening to spruikers), however, you will have lower Risk. Which is imperative when you are first starting out.

Reality is that most Day Traders and many beginners fail, losing money to the markets. Choosing the right investment vehicle to suit your experience, knowledge, available capital and expectations for return/risk, will make or break your success.

Investors/Traders with some degree of experience should consider some of the other vehicles for Stocks, as a means to diversify their strategy. Not as a means to perform better than the approach they are currently adopting.