Every investor brings his or her unique approach to investment. But there are a number of commonly identifiable investment styles or tactics used in trading stocks, these include:
A value investor looks to pick up stock that is trading at a bargain, i.e., stock that is undervalued relative to its intrinsic worth or future prospects.
Value investors hope that others will eventually recognise an undervalued stock's true worth, buy it and thus cause its price to rise. When such a stock appears to be fully valued, the value investor will sell it and start searching for other bargains, and the cycle begins again.
Why would a stock be undervalued? Well, the stock may be small or little known and the resulting lack of buzz may create a bargain for the diligent value investor. The sector to which the stock belongs may also have fallen out of favour.
So how do you spot a bargain? You can examine the company's fundamentals and several key ratios - P/E ratio, price/book value, and dividend yield - to arrive at a "true" value for the company. Of course, you may find that an apparently undervalued stock may in fact be full-valued on closer examination.
Risks of Value investing
If you do not like taking risks, then you could well be a value investor. Value investing is a relatively low-risk trading strategy.
Value investing requires a lot of research work. First of all, you have to identify the value stocks by monitoring the financial press or investing sites, then decide if the company has merit and if its fundamentals are heading in the right direction.
A contrarian investor ignores market trends and buys neglected and depressed stocks of well-managed companies.
The contrarian investor tends to select the opposite of what most people are investing in at the moment by looking for healthy companies in unpopular industries or overlooked firms. Stock that is falling in price becomes more attractive while one rising in price becomes less so. By purchasing the stock of companies that are out of favour, the contrarian can realize profits when these companies regain popularity.
Stocks with low market prices and low P/E ratios are particular favourites with contrarians. However, the contrarian must take care that a low stock price is really undeserved; the contrarian should also consider the company's balance sheet, management and market structure before making an investment decision.
Risks of Contrarian investing
Contrarian investing is a relatively high-risk trading tactic. If you are risk averse, then this is not the best investing approach for you.
Contrarian investing requires a lot of patience, discipline and conviction. Going against the mob psychology may not be your style.
Momentum investors buy stocks that have "momentum" - companies that are improving at a faster rate than the market or than the market currently expects. The reasoning behind this strategy is that even though the stock may be already highly priced, investors may not yet have priced in all positive news about the stock, or further good news about the stock is expected.
Momentum investors also look for average companies that are becoming good or good companies that are becoming great. It is in this transition that momentum investors make their money.
Risks of Momentum investing
You may have heard the phrase "buy low, sell high". Momentum investors "buy high, sell higher" and thus they risk losing more money than investors who buy undervalued stock. Therefore, although momentum investing may generate profits in the short-term, it is a low-return, high-risk strategy in the long term.
The growth investor picks the stocks of companies whose sales and earnings are expected to grow substantially. The rationale: if earnings are growing, so too should the share price. If you do not like taking risks, you might consider this trading strategy. Growth investing is relatively low-risk.
Growth stocks are usually those of smaller companies that have grown significantly in the past three to five years and are expected to continue growing for the next few years.
Risks of Growth investing
If you expect to make a quick killing in the short-term, growth investing is not for you. Growth investing is typically for the long term; it carries the expectation that growth stocks will pay dividends and capital appreciation in the future.