Choosing what to invest in is ideally less like window shopping and more like an investigation if you want to base your choices on information rather than feelings. Some people still do choose what to invest in by what they feel is a good investment. However, at best, that is an intuitive approach to investing, and there are several other ways to go about choosing what to invest in that might be more worth while.
Fundamental analysis studies the financial profile of a company in detail. This can be as in depth and comprehensive as one makes it. For example, one may simply look at a company’s earnings per share for the past five quarters and choose what to invest in based on that. Others may be more thorough and study the company’s revenue trend, profit margin, asset management, and so forth. What fundamental analysis doesn’t reveal however, is the future.
To glean how an investment will perform in the future requires a certain amount of informed foresight. For example, if it’s the autumn, you can induce some birds will fly south for the winter. Financially, if it’s a business that follows a business cycle and the high end of that cycle has passed, revenue’s might decline. Businesses are not as predictable as bird’s flight patterns however, so choosing what to invest in also involves looking at another aspect of the market.
Supply and Demand:
Businesses might not be worth investing in at all. If the demand for businesses services is lower than a commodity for example, then maybe commodities are a better investment. To know that an investor would look at any number of factors that can influence both the availability and need for a certain product such as corn. For example, when corn based ethanol became a legislated fuel additive, it affected the price of corn. However, if large amounts of farmers were to switch to another form of feed for their livestock in the future, that could affect the price of corn as well.
Knowing how to choose what to invest in also involves understanding a little more about economics. Economics is like a barometer for markets of all kinds. For example, if an economy is in a long term secular trend what does this suggest for the market? It could mean business cycles will be suppressed despite demand, or it could mean prices won’t rise much for businesses causing less profit if their costs do increase. The economy is made up of a lot of components such as employment, monetary policy, trade balance and so forth. Each economic component can affect how well an investment will perform.
Technical analysis is the chartists way of choosing what to invest in. Chartists look at the price movement of a company’s or product’s price movement over time and draw conclusions based on patterns of probability. Technical analysis helps some investors choose what to invest in because they believe the patterns they see confirm a higher probability of a price movement. Although technical analysis is used more for short-term trading, investors may also use it to assess medium and longer term price patterns.