Other stock investment methods

Other stock investment methods

Momentum Investing

Although there are many other stock picking methods, I'd like to highlight one more called momentum investing. Momentum investing combines growth investing with technical analysis.

Momentum players invest in stocks that have a parabolic chart pattern. In other words, the stock price is going almost straight up.

I can't help but feel that momentum investing is a fancy way to describe the old "greater fool" investing technique. If you use the greater fool technique, you don't care that the stock is overvalued when you buy it. You just want to sell it to the next fool at a higher price.

Momentum investors claim that they won't be the last fool, and that they want to invest in stocks that are going up now, not next year. Fair enough, but if you trade stocks using momentum techniques, you need stocks that have plenty of liquidity and you've got to stay glued to your computer screen because when the music stops, you'll need to get out of the stock in a hurry.

The best investment technique

There are plenty of ways to make money in stocks, and there are plenty of ways to lose money in stocks, but of the various ways to invest, I'd have to say that fundamental analysis has the best prospects for yielding success. But don't forget that it's still tough to beat the market.

If you look at a company and find it has good growth prospects and good management, others in the market also will discover this. They'll bid up the stock's price, so all of your research may not give you the edge that you think it might.

Instead of spending your time trying to beat the market, I'd suggest that you invest your time finding ways to reduce your tax liability. Even the most successful stock pickers have only beaten market averages by a few percent, and even random stock selections have beaten the market just as often.

Since taxes eat up about a third of your profits, trying to beat the IRS, instead of trying to beat the market, generally proves more profitable.

Peter Lynch took on more risk

You can, however, beat market averages simply by accepting more risk. Peter Lynch is a good example of this.

Peter Lynch is one of the most famous mutual fund managers around. He ran the Fidelity Magellan fund from 1977 to 1990. During this time he returned a total of 2,700 percent, while the Standard & Poor's 500 average returned only 570 percent.

But there are a few chinks in Lynch's record. First, during the early years of Lynch's management, when Lynch racked up his biggest gains, the fund was small, was closed to outside investors, and most of the money was provided by Fidelity's owners and employees.

Second, Lynch invested in risky stocks. At one point, when Chrysler was on the verge of bankruptcy, Lynch invested the largest amount legally possible in the automaker. Was this shrewd investing or simply risky investing? Or perhaps both?

Lynch and 1987 crash

The market crash of 1987 also showed that Lynch's Magellan fund was investing in risky stocks. On Black Monday the Dow Jones Industrial Average dropped 23 percent, while the Magellan Fund dropped 32 percent.

Moreover, a government probe into the crash excoriated Fidelity and the Magellan fund for exacerbating the market with panicky sales of stocks in the first half-hour of trading on the day of the crash.

Don't get me wrong. Risk has it's place in anyone's portfolio. Just don't assume that beating market averages is evidence of superior investing skills. Maybe it only shows the fund is lucky or risky.