Finance Articles

The Most Important Investment Principle

Most people are attracted to an investment after it makes a big jump in price and they keep away from an investment after it falls in price. Successful professional investors tend to do the opposite.

Professional investors understand the most important investment principle "you don't make money from what an investment did before you owned it, you make money from what it does after you own it."

An investment you don't own that just went up sharply made someone else a profit or if it dropped rapidly it made someone else a loss. The question the professional is interested in answering is what is it likely to do from now on.

What the professional is looking to buy is an investment that is currently undervalued. For this reason they may be attracted far more to an investment that has dropped in price rather than one that has just made a substantial rise in price.

The undervalued investment that they are seeking could be an investment whose fundamental value today is more than its current market price or it could be an investment whose potential for capital growth is being underestimated by the market place.

Markets are largely driven by psychology in the short term and sometimes also in medium term. But in the long term price tends to be determined by practical realities. The psychology caused the fluctuations in the market but if you iron out those short term ups and downs you will generally see steady consistent trends.

For this reason periods of rapid growth above the trend will be followed by periods of downward market correction where the market catches its breath and lets reality catch up. The stronger and longer the rapid growth the more severe that correction will be. A mild recovery may result in slow growth or no growth whereas a severe recovery period may involve a substantial drop in market price.

Often during those correction phases psychology will kick in again and the market players will over react resulting in prices dropping substantially below fundamental values. This is when the amateurs are running scared but the professionals are bargain hunting. The professionals know that substantial drops below the trend will be followed sooner or later by an upward correction toward the long term trend.

These patterns of fluctuations and corrections occur in all traded markets such as stocks, currency, property and even small businesses, but in order to take advantage of them you need to understand the principles for calculating fundamental valuation for the particular investment you are interested in.

This would mean knowing how to calculate the real value of a company in the case of stock market or the real value of real estate in the case of property investing. If you learn how to do this and if you learn what drives long term capital growth in that market then you too will be able to see when the price is being driven mostly by emotion and when it is being driven mostly by practical considerations.

This style of investing requires considerable knowledge and considerable work because you will spend a lot more time analyzing potential investments than you will spend buying or selling. You have to be a person who enjoys analyzing and gets pleasure out of finding the opportunities that others are missing.

Having said that it can also be very profitable.

Warren Buffett has made billions from this form of investing in the stock market and Donald Trump has made billions from finding substantially undervalued property and recognizing the potential. If you are willing to learn the skills and do the work then perhaps you could join them.

Learn how to get rich in just 5 minutes a day with James Delrojo?s ?The Busy Person?s Guide to Riches?. Go to http://www.riches.in5minutesperday.com

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