Many new investors find the classifications or styles of investing confusing. When you first start studying about equity (and debt) investing, you’ll find many teachers and authors talk about styles of investments and investors. These classifications often vary by the school-of-thought the author subscribes to but let’s define some of the most common.
First up, we have the Fundamentalist
You might also hear this style called Buy and Hold (or Buy and Pray by some cynics). The name refers to the fact that decisions to buy, hold and sell are based on the fundamental business aspects of the company. It is primarily a long-term investment strategy.
Another widely used term that overlaps Fundamental is Value Investing. It’s most famous success story focuses on Warren Buffet who was mentored by Benjamin Graham, a professor at Columbia University who wrote one of the most widely read books: The Intelligent Investor.
The Fundamental or Value Investor studies the company’s quarterly and annual reports and looks at the financial statements, along with the past performance to project future earnings, dividends and stock prices (or the likelihood of default on bonds). Some attention is also directed towards the economic environment the company does business in.
Technical Investors and Traders Use Market Prices
If an investor believes the markets are primarily fair and the secondary market’s prices factor in all relevant data, then instead of studying income statements and balance sheets, they look at how the stock moves relative to other issues and the market as a whole.
Charts of the stocks’ or bonds’ sales prices are studied to gage how they react to news, economic cycles or various time frames. A wide assortment of patterns are discerned; maybe you’ve heard terms like:
- Head-and-Shoulders pattern,
- the Darvas Box,
- Double or Triple Bottoms/Tops,
- Support and Resistance.
By studying these charts, the investor/trader attempts to time their transactions to take advantage of the symbol’s projected price moves.
Macroeconomics Guides Top Down Investors
This style features prominently in a technique called sector rotation. It focuses on the broad economic climate and world-wide trends, to identify which areas will expand or contract as growth rates wax and wane.
If you’ve ever heard the saying “demographics is destiny”, you’ve been exposed to the idea that larger forces impact a particular company’s ability to grow and profit as much or more than their individual actions.
Top Down investors look at places like China and India with their huge populations and attempt to find investments that benefit from the growth of these economies or changes in demand brought on by the aging populations of Western Europe and Japan.
Bottom Up Investors Follow the News
By focusing on how a particular company plans to grow or improve their products and services, a Bottom-Up investor has a lot in common with a fundamentalist. They really dig in, seeking to determine how the company’s leadership plans and executes their strategies. So, when a CEO quits or is fired, or a competitor suffers a setback, the Bottom-Up investor takes note and makes changes to their holdings.
Quantitative Traders Use Mathematics to Project Changes in Prices
An equity’s metrics and ratios guide a quant’s investment decisions. Truthfully, all types of investors need to do some numbers crunching. It’s a lot easier now with digital data and massive databases but in finance, the story is told in dollars and cents (or pounds, euros, yuan or yen).
Quants generally apply mathematical or statistical modeling to understand what drives and investment’s value and then uses that to predict a future value. Because it requires many calculations and quick responses to often small changes, pure quantitative trading requires massive databases and complex software and is reserved for large funds and money management companies.
Most investors and traders use a combination of styles but keep these general definitions handy as you learn more about investing and which of the types you want to learn to emulate.
So remember, your top five types or styles of investors and traders in the equity and debt markets are:
1. Fundamental (Buy and Hold or Value)
Uses a company’s financial statements and the general economic environment to try and project future earnings and changes in a stock’s price.
Based on prices in the secondary markets (NYSE, NASDAQ, etc.), technical traders are trying to project future stock price via recurring patterns in charts.
3. Top Down
Macro economic trends applied to a company or sector’s future earnings potential.
4. Bottom Up
Specific company events such as personnel changes, legal actions, new product development and competitor’s actions are factored in to project future equity prices and debt repayments.
Calculates metrics and ratios and applies mathematical formulas to project future movements in prices.
That’s it for today – later we’ll look at the mechanics of using the various ways to invest and trade the equity (and debt) markets.
Live Long and Prosper, Leah, the MoneyDiva.com