no asked in Business & FinanceInvesting · 9 years ago

Investing questions from an 18 year old new to the market?

I have about 8k of money from working that I am going to invest in the stock market. I am kind of afraid that I'm going to lose all my money quickly. How do i diversify my stocks? I have a couple of cheap biotech companies that I did research on that I want to buy. They are around 4 dollars per share. Have a beta of around 2.15 so they are pretty speculative. I don't want to invest ALL my money in short term gains/speculative shocks. How many shares should I buy initially?

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  • John W
    Lv 7
    9 years ago
    Favorite Answer

    Well, cheap biotech stocks are cheap for a reason. The chances of a return are downright slim to none. Yes there will be the occasional big win out of thousands if not millions of losers.

    The interesting thing is that you're asking about how much to invest which is an often overlooked question. How much determines the risk that you are assuming, if you invest nothing, you risk nothing but if you invest everything, you risk everything thus the amount you invest determines where along a continuum of risk you are.

    Let's forget about how you're falling for a newbie trap by trying to pick biotech stocks for the moment and talk about an idealized investment opportunity, that of a coin toss that pays 2 to 1, that means there is a 50% Chance of winning and if you win you receive twice your wager and the return of your wager whereas if you lose, you lose your wager, also you can wager on subsequent coin tosses with the same payout as often as you'd like. This is a money making opportunity as you would expect to make $1.50 for every $1 lost, a net gain of $0.50. How much would you wager with each toss? If you wager nothing, you gain nothing, you know that the more you wager, the more you stand to gain but if you wager everything then you lose everything with the first loss so where does the wager go from making money to losing money and where does it give you the most growth. Well if you solve for maximum expected growth, you have what's called the Kelly Criterion named after a Bell labs physicist John L Kelly who derived it from the Shannon information theory used to maximize digital telecommunications so this is the very basis of the Internet. The earliest version of this concept dates back to Bernoulli's (yes that Bernoulli) 1738 paper "Specimen theoriae novae de mensura sortis (Exposition of a New Theory on the Measurement of Risk)" and if you use his approach of maximizing the geometric mean of outcomes, you can apply the concept to any known probability and outcome not just the binary ones that Kelly derived. Anyways, for the 2 to 1 coin toss, the maximum growth of wealth is achieved when you wager just 25% of your net wealth on each toss and you break even at 50%, any more than 50% and the occasional losses wipe out any gains that you might have. Basically excessive risk will turn a money making opportunity into a losing one.

    If you take a look at the historical performances of funds, the aggressive ones often show a decent ramp up over a few years and then a big drop that wipes everything out, this is because they've assumed excessive risk and over betted. It doesn't matter to the fund manager cause they get paid all along and get a few good years to claim their methods work while discounting the bad year as an anomaly perhaps closing the fund and starting a new one.

    The Kelly equation is

    F = (bp - q) / b

    where F is the fraction of wealth to wager, b is the payout ratio, p is the probability of winning and q is the probability of losing but the geometric mean of outcome is

    M = e^( p * ln( total wealth if you win ) + q * ln( total wealth if you lose ) )

    and you would chose your investment to maximize the value of M. Now as to how to diversify, if you had two simultaneous coin toss opportunities you would be maximizing the equation:

    M = e^( p^2 * ln( total wealth if you win both tosses ) + p*q * ln( total wealth if you win one but lost the other ) + q*p*ln( total wealth if you lost one but win the other ) + q^2 * ln( total wealth if you lost both ) )

    If both coin tosses were 2 to 1 opportunities, the maximum would be when you wagered 21% on each of them (note that means you're risking 42% of your portfolio). If one toss was a 2 to 1 opportunity but the other was a 3 to 1 opportunity then the optimal growth would be when you wagered 21% on the 2 to 1 opportunity and 31% on the 3 to 1 opportunity. This is counter to how most people think in that most would simply choose the 3 to 1 opportunity over the 2 to 1 opportunity but in reality the optimal is still to play both.

    Of course, knowing the actual probabilities to be able to proportion the investments optimally isn't likely but the more you diversify, the better and the amount that should be risked on each is relatively small.

    The biotech plays are low probabilities high return plays and hence you should risk very little on them, I would say none as they are probably negative expected value plays.

    You should find a low fee total market fund to invest in as a fund is the easiest and cheapest way to diversify widely, keep your overall portfolio between 25% to 50% stocks with the rest kept relatively risk free in bonds and rebalance periodically.

  • 9 years ago

    Idea 1:

    Invest the $8,000 into a mutual fund since its not uncommon to achieve 8% to 12% per year. Create a regular, non retirement account so your money is not locked up. Now you don’t have to worry about the day trading regulation or researching corporations.

    Idea 2:

    Learn how to take advantage of charts and patterns to profit on a weekly basis. Join a subscription like http://www.timothysykes.com/ . The benefit is to watch all of his training videos before investing, learn how to understand the SEC fillings, research process, manipulation, receive a daily stock watch list etc....

    How many companies succeed? Picking out the next Google is almost impossible but determining which companies are going to fail is much easier. Short Selling a stock is when you sell shares of a company you don’t own and you buy them back at a lower price for a capital gain. Understand how to buy and to short sell is essential to trading which is the main reason why I suggested the above web site. You can view his trades below. If you have any questions feel free to email me. Sorry for not answering all of your questions.

    http://profit.ly/user/timothysykes/trades

    Good luck and cut losses quickly!

  • 9 years ago

    You don't say what you are investing for, and how much risk you want to take on. If you earned the money and are thinking of retirement, consider a Roth IRA. Your money grows tax free, and when you retire you can withdraw it tax free as well. You can invest up to $5,000 per year in it.

    But you are right - you can and probably will lose money fast on risky or speculative junk. Try a good mutual fund, index fund or ETF - you will get professional management at a very low cost to you. Not to mention excellent diversity, at a risk level you are comfortable with.

    You first need to pick a company to invest through. Some of the best are Vanguard, T. Rowe Price, Fidelity, and Schwab. Avoid the big banks like the plague. Don't let them rip you off with loads (sales charges) and fees. Check how much the company charges you as an expense ratio. A good one might charge you 0.2-0.8 %. If they charge more than 1% than go somewhere else. And if they charge any kind of 12b-1 fee, hold on to your wallet and RUN.

    For more information, try looking at

    https://personal.vanguard.com/us/funds/vanguard/al...

    and play with it, comparing funds with more or less risk.

    Do some reading online such as

    http://www.vanguard.com/us/insights

    for some important investment truths and read books like Investing for Dummies for a good intro.

  • 9 years ago

    You should invest in a basket of blue chips (e.g. Coke, Pepsi, Chevron...) or an ETF like SPY (S&P 500) or DVY (large cap dividend).

    Too avoid loosing $ sell when the market is below either 200 day or 150 day moving average. Buy back when above whichever moving average you choose.

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  • 9 years ago

    you made the first mistake of being new to the stock market, buy higher and better quality price stocks. you'll get what you pay for, but do more reseach

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