Margin of safety is simply a value stock investing model where the investor assigns a margin of safety to his/her value assessments. In value investing, the investor estimates (or predicts) the intrinsic value of a stock. The concept is that every stock has an intrinsic value and price changes from this intrinsic value is just deviations resulting from the actions of market forces. The stock will often return to its intrinsic value when the market forces weaken.

Thus investors who buy stocks when the trading price is below the intrinsic value and investors who sell stocks when the trading price is above the intrinsic value will profit. But what make value investing difficult is predicting the intrinsic value of stock. There are no established rules for finding out this. Investors should develop their own strategies and models for this purpose, according to availability of information and analysis tools he has.

Many traders use different indicators like book value, open offer, P/E ratio, asset to liability ratio, institutional investments, investments in other companies, etc to finding the intrinsic value of the stock.Margin of safety investing strategy easily overcome this difficulty of predicting the intrinsic value. Investors assign a safety margin as percent of predicted intrinsic value (usually is 30 to 40 percent of intrinsic value).

Margin of safety investors only buy stocks when they are trading below margin of safety. In this way he/she can minimize the risk/error of predicting the intrinsic value. The more the percentage of margin of safety the lower the chance of risk, and the better the chance of profit. For example is the predicted intrinsic value of a stock is $10 and margin of safety is 30%, then the trader only buys the stock if the current trading price is below $7 ($10 – 30% of $10). If the actual intrinsic value is only $9, and the stock returns to this level, the investor will have a profit worth $2. The main advantage of margin of safety investing strategy is that it offers a margin rather than a fixed price to reduce risk.

It favors all type of investors, both experienced and novice investors, and does not necessitates any position sizing or market performance requirements. But the disadvantages are that it does not present any rules for assigning margin of safety and does not consider market factors. Also there is chance of substantial loss when margin of safety is less and scarcity of opportunities when margin of safety is high.

‘Buy and Hold’
The reason why most people believe that this is the safest investment strategy for the stock market is because that is exactly what their financial advisers have told them. Have you ever heard the phrase “The key to successful investing is Time In the Market NOT Timing the Market”

I believe that this is a lazy approach to investing and is really just an excuse to hide the fact that some financial advisers have no idea what the market is doing. Wouldn’t successful investors use multiple investment strategies for the stock market? If the market is at a record high and there is a chance of a correction then surely there is something that you can do (other than selling your stocks) to protect some of your profits?

The reason why financial advisers don’t want you to know about any other investment strategies for the stock market (other than buy and hold) is because it isn’t in their interest for you to know about them. They want you to remain reliant on their advice and have you feel as if the stock market is a very scary and dangerous tool – only to be tamed by the so called experts.
What is your opinion? I certainly believe that at times the stock market can be very scary and dangerous but like any thing; the more you educate yourself the more comfortable you will feel with it.

So what are some Investment Strategies for the Stock Market other than buy and hold?
Let’s have a quick look one very simply investment strategies that can be used to great effect on any stock market.

Covered Calls
This is one of the most effective, low risk investment strategies that can be used on the stock market. The basic idea to sell call options on a stock that you own. What? I hear you saying. In simple terms it means that you are renting out your shares for a monthly premium and in return you are giving somebody the option to buy your shares at a predetermined price that is higher than what you paid for them.

Let’s say you own 1000 XYZ shares that are worth $15.00 each. People will pay you a monthly premium to have the option to buy these XYZ shares at a predetermined price within a predetermined time frame.

For instance someone might offer you $500 for the right to buy your shares at $16.00 within the next month. Why would they do this? Because if the shares happen rise up to $18.00 they will be able to buy 1000 XYZ shares at a $2.00 discount per share ($18-$16).

The great thing about this strategy is that both parties can win e.g. If this was to happen you would be happy too because you would get to keep the $500 premium and you would also make $1.00 from every share that you sold because you bought them at $15.00 and sold them at $16.00.

What happens if the share price was to go down?
If the share price was to go down from $15.00 to $13.00 then you would still get to keep the $500 premium which would reduce your paper loss from $2.00 per share to $1.50 per share.

Writing covered calls (or renting out your shares) is one of the most commonly used investment strategies by the rich. It is a great low risk low risk investment strategy for the stock market that everybody deserves to know about.

So there you have it a simple investment strategy for the stock market that can help increase your cash flow and also gives you downside protection. What more could you ask for in a stock market investment strategy? So next time you see your financial adviser ask them about covered calls and see what response you get. My bet is they probably won’t even know what you’re talking about because their university course didn’t teach that subject.

Pretty much every investor uses one of three general investment strategies. These are: fundamental analysis, technical analysis and buying and holding the market.

A brief examination of each of these techniques will help an investor decide which best suits their personal profile.

Fundamental Analysis
The most straightforward approach of fundamental analysis is a basic examination of a stock versus the value of the company and its expected future earnings. Based on the company’s financial publications it should be relatively easy to determine weather a stock is undervalued, overvalued or somewhere in-between. The trader assumes that the market price will correct itself and the price per share will consequently go up or down, unless there are any unforeseen events or hidden value traps.

Technical Analysis
Using technical analysis, the investor makes an attempt to predict future share prices based on the direction of the market, trading volumes and past prices. This approach assumes that the market and individual stock prices loosely follow discernible patterns, or at least stay within a certain bandwidth of it. Once the beginning of a pattern is identified, the remainder of the pattern can theoretically be predicted, hopefully well enough to yield returns in excess of the general market. Research has shown that solely using technical analysis as your strategy, does not work well. Yet, there are some indicators such as pivot point resistance or support levels that can actually hold up, most likely due to the wide acceptance and adoption of the method under the professional traders.

Buying and Holding the Market
The approach of “buying and holding the market” is to have a portfolio that could hold it’s benchmark against the market performance. For this strategy the investor buys a basket of stock that resembles the stock market or the S&P 500 assuming that the overall direction of the market performance is upward. The investor buys a large number of diversified stocks and does not need to buy every single stock in the index, although that could be achieved by buying stocks of an S&P 500 Index mutual fund. This approach can be used as a benchmark performance tool, as no other investment approach is valid unless it’s able to outperform the stock market over the long run. In the event that investment approaches do perform above market performance with the same risk, the difference is called excess return, which represents the added value of the used investment approach.

The investment approach you decide to use depends on your conceptual view of the two principal stock market theories. In the light of the efficient market theory, the stock price reflects all publicly available information about the company in question, which results in the trading price coming very close to the true value of the share price. Meaning that on average the price reflects the fair value of the stock, but not all the time, as variations of this price can exist.

On the other hand, there’s the school of thought that these prices are unpredictable and too random, and cannot be used to generate excess returns. In that case, there is no point in using the fundamental approach seeking stocks that are selling under their actual value. Alternatively, one could concentrate more on developing a more efficient portfolio, instead of selecting a certain kind of stock. This would be a portfolio that provides returns closest to the market’s return at a specified level of market risk. The investor simply determines the amount of risk that is acceptable and builds the portfolio based accordingly.

Investors believing that the market is not efficient for the reason that buyers receive, perceive and evaluate information differently, causing the prices to deviate from their true value can look for undervalued stocks through diligent analysis. Going forward, this would enable them to outperform the benchmark of buying and holding the market. As backed by many studies it’s safe to assume that the market is often inefficient and therefore there are numerous ways of outperforming the market with your portfolio. Your excess returns can generally be 2 -6 percent at a risk free rate.

Anything higher is most likely an abnormal return, which is the out-performance over the risk-adjusted return. Just beware, as this can also be a negative abnormal return. Nevertheless a small consistent excess return can also lead to great wealth.