Many investors love to buy cheap stocks, but as Mr O’Neil (investors.com) puts it: “Stocks are cheap for a reason”. In many (but not ALL) cases, investors do not realize that the stocks they bought cheaply belongs to a company mired in problems with slowing earnings, sales growth and shrinking market share. These are bad traits for a stock to have, regardless of how cheap it is.

Nonetheless, although most investors have lost money buying cheap stocks, there are still many savvy investors (read: Warren Buffett) who have made fortunes buying cheap BUT GOOD stocks. How did they do it? Below are some guidelines:

Buy a business, not a stock.

When evaluating a stock, see yourself as a business owner, not a stock investor. Only buy businesses that you understand. When you understand a business, you will be able to evaluate important questions like: Is the company’s stock cheap because it is losing market share? What are the challenges faced by the company?

Buy stocks in companies that have a proven track record.

This includes a consistently good EPS, sales, equity and free cash flow growth rate and a long history of great ROIC (above 10% for the last 10 years).

Buy stocks that have a big MOAT

A moat is a ‘protective shield’ that a company has that prevents other companies from invading their territory. Examples of moats include

• Brand name: The company has a very strong brand name, making it difficult for other companies to compete with them. An excellent example is “Apple”, with its group of die-hard fans.
• Secret: The company has a patent or trade secret that makes competition illegal or very difficult. Example: 3M.

Buy stocks with a good and honest management

Traits of honest management include admitting their mistakes (if the company did not do well for one quarter, they should admit it and explain how they intend to improve the situation) and accepting a reasonable compensation for their work.

How to buy Cheap Stocks?

At this point, you may be wondering: If a company has such an excellent track record and characteristics, why is the stock cheap?

Most of the time, these companies stocks are cheap because of a temporary problem (such as missing EPS estimate) or because the overall market is bearish. At times like this, you can normally buy the stocks cheaply, preferable at a 50% discount.

As long as one does his/her research diligently and is willing to wait patiently for a good price, he/she can definitely join the ranks of successful investors. A bear market (which is NOW) presents the best buying opportunities.

Opinions about day trading vary widely. Some people swear it is the best way ever to make a profit in the stock market…others, including the SEC (Securities and Exchange Commission) advise strongly against day trading, insisting it is too risky. As with many things having to do with investing and the stock market you will hear all kinds of things about day trading. The trick is to sort the information out.

But what exactly is day trading and why do so many advise against it? Day traders literally trade everyday, all day, buying and selling sometimes very rapidly. They hope to see a stock going up, for instance, quickly buy a block of that stock and then sell it again as soon as it has risen enough to make a reasonable profit. If everything works right the trader makes a profit every day from the normal movement of stock prices up and down.

Day traders try to concentrate on certain stocks that are particularly suitable for day trading. The most important thing is that the stock must be one that is highly liquid, which means it is bought and sold often. This allows the day trader to buy and sell easily. Liquidity varies with market volume and the size and nature of the business. In general almost all stocks on the major exchanges are more than liquid enough for day trading purposes.

To be suitable for day trading a stock also needs to be sold in sufficient volume that the buying and selling activity of one trader won’t affect the market price of the stock. Day traders usually buy and sell big blocks of stock so a good day trading stock needs to have at least 500,000 shares traded a day. Day traders also look for stocks that have high volatility, which means that the price goes up and down rapidly. A stock with a rapidly changing price is perfect for day trading. The ideal is at movement of at least $2 a day.

A day trader also needs to be able to find sufficient real time information of the orders for a stock. This is sometimes called price transparency or market depth and lets the trader know how much stock they can probably move in a certain period of time. Traders need to have access to the NASDAQ level II quote screens in order to gather this information.

There is nothing illegal about day trading but it can be extremely risky. Almost all day traders are working with borrowed funds which they hope to increase through their buying and selling. If the NYSE and the NASDAQ classify someone as a “pattern day trader” then that trader must trade through a margin account with at least $25,000 as a deposit in it. The broker who handles the account will require that further deposits be made if the trader’s holdings drop too far in value.

Because day trading is so risky the Securities and Exchange Commission has devoted quite a bit of energy to spreading warnings about the practice. Their fear is that people will become involved without understanding how much money they can lose in a very short time.

Anyone who decides to try day trading can expect to suffer huge losses as they try to learn how to do it successfully. Very few will succeed and make money in day trading. No one should ever try day trading with money that they cannot afford to lose without any problems.

Day traders are not really investors. They buy and sell over the span of time as short as seconds or minutes. They never hold stock after the close of the trading day because the risk of overnight price changes is too great for them. Day trading is really speculating; some call it gambling.

Be sure to avoid websites which promote day trading by talking about the great profit potential and then offer you ‘expert information’ or ‘hot tips’ for money. The recommendations are usually actually paid for themselves and the advice is worthless.

Trading in the Stock Market involves risk, but if you know what you are doing you stand the chance of making a lot of money.

If you have not thought before of what trading is then the best analogy to consider is that trading is a bit like operating a small business. You have to commit your money to a particular opportunity when you start a business and you use your knowledge and skills in assessing the chance that a chosen business opportunity will prove profitable.

A business will possibly fail and many do, but the research you do in advance should make you confident that you will make money. Sometimes you will lose money, but if you are good you will make more profit than losses. Trading is in this way just like planning to start a business, and if you are wise it will be your knowledge and research that will improve the odds for you over the next man.

To be a successful trader running a day trading system, you need to work to understand the market in your area of expertise. Don’t be fooled into thinking that being a trader is easy and that money will fall into your bank account. Just like anything else you need to develop your own market appreciation as a skill and apply that skill to make money.

Traders can and do make money on in an up or down market, and the best of them use their own technically based analysis as well applying fundamental principles of the stock market to make their profits. Traders of stocks have many and varied approaches to how they invest in the market. Some buyers love the gambling aspect and like to take large gambles when they invest.

They choose the most risky stocks and have to accept substantial losses as well as enjoying the equally high gains. Others prefer to look for safer opportunities. Both approaches are equally acceptable under certain circumstances, and it is, of course, the long term profitability over many trades that matters. Investors are slightly different from traders, and investors put their money into stocks over a longer period and they also get dividend as a reward for investing at the end of every financial year. Sometimes companies also offer premium shares to longer term investors as existing share holders, as a bonus. However, although this is not seen as risky as short term trading in the stock market, investing can also be a dangerous, yet profitable endeavor.

Many people have been burnt and decide not to ever invest or trade again, while others thrive and prosper. The main thing to realize before anyone starts trading is that although it may appear easy, there is a lot of knowledge and skill in profitable trading. So, don’t make the mistake of thinking that you can just expect to make money without first developing knowledge and experience, or accessing the knowledge of others within a stock trading system that you trust.

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