Bear Mountain Bull

Investing Primer — BMB Do’s and Don’ts

So you want to be an investor, or maybe you already are. Maybe you own a few stocks, and you’ve got some money in a few mutual funds in your 401k plan. Are you making money? How are your stocks doing today? How has the market been performing lately? Which sectors are the strongest right now? When will you sell your stocks if they go up? Better yet, what will you do with them if they go down? These are questions that, as an investor, you should continually be asking yourself. It’s fairly easy to buy stocks - but it’s not nearly as simple to know what you should do with them once you own them! The smart investor has a plan — a method for choosing the right stocks, for deciding when to buy them, and just as important, for deciding when to sell them. Here some ideas for you to consider:

DO: Educate Yourself — and educate yourself some more. An educated investor is a better investor. Take the time to learn as much as you can about the markets. Understand the difference between stocks and bonds, ETFs and mutual funds, growth vs. value stocks, market orders, limit orders and stop orders. If you’re investing in mutual funds (like those in your 401k plan), research the funds and know what stocks and/or bonds those funds are investing in. You might find that some of the funds own a lot of the same stocks - so you may not be diversifying as much as you think. Read as much about the markets as you possibly can, and learn how to read stock charts and what they can tell you (you can find some of BMB’s reading recommendations here). Learn how to identify market trends. Then continue to pay attention to the markets and how (and why!) they’re moving.

DON’T: Chase hot tips, hot stocks — Don’t buy stocks based on tips from your buddies or your in-laws: take their tips under advisement, then do your own homework. Don’t base your investment decisions on what you hear television “analysts” say, or what you see on the magazine covers. In general, by the time a stock becomes the one everyone is talking about, it’s way too late, and it’s more likely to move down than up. When rebalancing your 401k, be wary of the funds that have run up a lot in the past year or two - you might actually be better off looking at the other funds. You should base your decisions on where the market will be going, not where it’s been. Also, pay attention to the entire market. After all, not all sectors of the market are profitable at the same time. Don’t get stuck in a rut by trading only in your “comfort zone” - just because you’re most familiar with technology stocks, that doesn’t mean that those are the stocks you should be buying.

DO: Manage Your Capital, Manage Your Positions — Manage your trading capital wisely. Regardless of how attractive a position may seem, avoid committing too much of your money to any one position. Try to understand which asset classes (stocks, bond, cash, commodities) might be more profitable than the others at this point in time, and favor those asset classes. If the market isn’t moving, you don’t have to be invested - there are times when “cash is king”. Preserve your capital for times when the market is more cooperative. Sometimes, investing isn’t so much about making money as it is about not losing it. Once you’ve made your investments, don’t ignore them. Pay attention to what the markets are doing and where your stocks or funds stand. Keep up with where your stop orders are - maybe they should be bumped up, or they may have been cleared by your broker after a certain period of time or a dividend payment. Keep an eye on your 401k - it’s your retirement, and that time will be here before you know it. Don’t assume it will just grow by itself over time. Know whether you’re winning or losing. If you’re losing, figure out why and remedy the situation.

DON’T: Fight the Trend — You’ve heard all the cliches: “the trend is your friend”, “a rising tide lifts all boats”, and on and on. The reality is: they’re all true. Almost anyone can look good picking stocks in a bull market, since a large majority of stocks will go up in that environment. So take advantage of that trend and go with it. But learn to recognize when that trend changes, and change your behavior accordingly. Make sure your stops are in place and let the market take you out of your winning positions. From there, be very careful in buying during the downtrends. Examine each potential trade in terms of the overall market, the sector’s relative strength, the short-term and longer term trends. If the market is working against you, consider staying out of the market until conditions improve.

DO: Buy Strong Stocks — Learn how to recognize which stocks are strong, both fundamentally and technically (again, check the BMB Recommended Reading section for some help in this area). Consider the state and direction of the market, identify the leading sectors and choose strong stocks from those sectors. Learn to take what the market gives you - if the market isn’t offering good opportunities right now, stay away. The opportunities will come along.

DON’T: Buy “Cheap” Stocks — Don’t think that just because a stock is down 50% to 75% or more that it’s “cheap”. If a stock has fallen that far, there are good reasons. If a stock was once at $105 and is now under $5, that doesn’t necessarily mean it’s a bargain. That stock may very well never see $105 again, and it might be on its way to $0. Don’t try to “call” the bottom on a stock that’s plunging, either. If it’s falling, let it fall (you’ve heard the expression, “Don’t try to catch a falling knife”). Let the market decide where the bottom should be, then let the stock (and the company!) recover and begin to show strength again before you consider buying it. Remember: “It’s a great company” is not a good reason to buy a stock. You’re buying the stock, not the company, and it’s the stock price that matters.

DO: Let Your Winners Run — Taking profits too quickly is one of the most common mistakes the average investor makes. Learn how to choose stocks with good risk/reward characteristics, and put stops in place when you buy to limit losses if they move against you right from the start. Once profitable, follow the stocks up with your stop orders and let the market decide when the run is over.

DON’T: Hang On To Losers — Another common investment mistake — and probably the most costly — is to hang on to losing positions far too long. The message here is simple: NEVER LOSE BIG. Every 50% loss starts out as a 10% loss - you can survive a lot more 10% losses than you can 50% losses. A position that’s down 50% must recover 100% to break even - a pretty tall order. Give your initial position some room to wander after you make the purchase, but decide right from the start how much risk you’re willing to take, be it a fixed percentage (7-10%) or a move below a significant support level on the chart. Don’t become attached to your stock picks - there will always be others. Let them go if they’re not “behaving”. Above all, do NOT hang on to a stock to wait until you get back to “even” - and do NOT “double down” on a losing stock! What if the stock never goes back up? What do you do then? That’s how those 10% losses turn into 50% losses or worse! Take that money that’s in a losing position and move it somewhere else, where you have a chance to make up your loss. If your bank started taking 20% of your money every year instead of paying you interest, wouldn’t you change banks? Of course you would. If your stock pick isn’t working, get out and move on. Let your big winners make up for your small losers.

Article contributed by RDS