Answered By :Sarath Rajapakse
There are three distinct strategies market players adopt when making (and timing) buying or selling decisions
- Buying any stock which in the buyers opinion and/or perception is "good" and holding it till the buyer gets the "gut feeling" that it is the right time to exit. We call this the BUY and HOLD strategy. This is usually practiced by those who cannot be bothered to read research reports or spend time "analysing" the merits and demerits of each stock they are interested in. Of course this works if you buy and hold a rather diversified portfolio for a long period of time since practically every profitable stock moves up in the long run (due to rise in nominal value of assets due to inflation and/or accumulation of accrued earnings).
- Buying undervalued stocks (low PER and PBV) and holding these till these are "fairly valued". This is called the fundamental analytical approach. The draw back in this strategy is that one cannot rely on outdated and inaccurate published financial accounts which invariably will be distorted by 'creative accounting' or 'earnings management' practices widely adopted by financial accountants in order to please their directors. However despite the drawbacks in this rather naive strategy it could reap in higher returns than one could expect to obtain by using a lazy BUY and HOLD strategy.
Finally, we have 'Technical Analysis' (TA) which is the most widely used strategy in global financial markets. In TA the practiioners use a 'preferred trading plan' based on prechosen statistical and /or stochastic indicators using past and present prices and/or volumes or price mevement patterns (on charts) of shares (or any other financial instruments) traded, to arrive at rational buying and selling decisions. Since the future prices of traded instruments are determined by the collective perceptions and expectations (rational or not so rational) of the market participants, this approach generally results in higher returns than what could be expected by adopting the previous two strategies.
(If interested in studying this in greater detail and depth one can refer the MEcon thesis of the author available for reference at the Economics Department library at the University of Colombo.