The Most Important Investing Advice… Ever
Posted by Karl Wiebe
November 5, 2007 at 6:44 pm
We’ve heard it a million times from all of the financial gurus out there: buy low and sell high and you too can retire with huge mansion, multiple luxury automobiles and a stock portfolio that is mimicked by thousands of followers. While the advice may be simple, it is definitely not easy for the vast majority of us. But why? Shouldn’t it be easy to pick a stock that has fallen a great deal and then ride it all the way to the end of the rainbow?
The short answer is no. One of the reasons is that when a specific stock tanks or the overall market dips, it’s usually for a specific reason, or even a multitude of reasons—the stock missed their earning reports, competition is squeezing or eliminating profit margins, a recession is looming, interest rates were adjusted, or currency fluctuations on the international stage suddenly sent stocks jumping around. How are we supposed to manage all of these different factors? How can we even know if a stock is “low†or if it is “high�
Many investors lament over not jumping into the “next big thing†only to watch it skyrocket—take the China stocks that have rallied over the past year for example, or the Uranium craze from a year earlier. We’ve all done it. Pull up any chart for any stock as start to mumble, “if only I’d bought a year ago (on the dip) and sold here (on the rise) and then bought again right after it bottomed out… I’d be a billionaire by now!â€
Can we predict the future? The answer is definitely “yesâ€! The unfortunate news is that we just can’t predict it very well. We can definitely predict that a stock will, at some point during it’s run, become overvalued, while at some point it will probably become undervalued. If you are a trader (as opposed to a long-term investor), the trick is too buy it when it’s undervalued and sell it when it’s overvalued.
A stock is usually undervalued when it is not popular among the majority of investors—this is when more orders are put in to sell the stock then their are buyers at a particular price, and as a result the stock price drops. The trick for savvy investors is to disagree with the majority of the investors about the future of the stock… and to be right.
Ask yourself some key questions the next time the overall S&P market drops 300 or 400 points. Do you agree with the gloomy forecast? For example, is there really a recession coming? Will the U.S. dollar remain weak? Is the sub-prime mortgage meltdown completely over, or is there more pain on the horizon?
More specifically: if one of the stocks that you are tracking has pulled back because of the overall market and not because of any specific information that pertains to that individual stock, then it may be a buying opportunity. After all, if you really like a sweater at the mall, and then one day it’s on sale, wouldn’t that be a great time to buy it? You wouldn’t say, “The sweater’s on sale today. There’s no way I’m buying it! I’ll wait for the price to come back up first.”
Instead of industry-wide concerns that affect the stock market as a whole, the questions you ask can also be stock or company-specific. Do you agree with the analysts estimates that future earnings will be weak? Is the future of the company looking great, or are there stormy days ahead for the company on your “watch list”?
What about the overall market for the product? Competition for the product? Are there expansion issues, or even management issues? These are all variables that can affect whether the company will increase (or even continue) it’s earnings, and this will hopefully send the stock higher.
If you have a stock on your “watch listâ€, and the price has recently fallen but the fundamentals remain unchanged, then consider it a bargain and consider buying it. There are a few critical steps that must be taken before buying the stock:
- Print off the annual reports for the past two years and read through them. They are almost always available on the website. Don’t just pour over numbers, but read the plans for the company and check out what all of their products and markets are.
- Decide if the company is a long or a short-term hold. If it’s a short-term flip, then be diligent, put in a stop-loss order and also a sell order on the high side. Be disciplined instead of greedy and take the money if the stock reaches your sell price. If it’s a long-term hold, then buy it and tell yourself that you are not going to touch it for at a year (and hopefully two) unless there are radical changes in the company’s direction (NOT the overall market’s direction).
- Buy on the dip. “You make money when you buy, not when you sell”. This old saying has been used in the real estate business for decades. Wait for a short-term drop and pull the trigger.
Buying stocks takes guts—especially when it’s dropping. Do the research and make that decision based on intelligent risk calculation instead of guesswork.
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I think knowing when to sell is just as important as knowing when to buy. Especially for me since I sell naked puts to enter positions. Don’t get me wrong, I love selling puts on a dip. I did it today with DWA naked puts.
You’re a brave man. I’ve been trying to get my broker to give me access to naked puts but I don’t have enough of a portfolio to soothe their fears. Puts against the SPY tend to be profitable especially this afternoon. If folks thought stocks were hard to trade, I could only imagine what they think when it comes to options, or currency, or commodities.
Leverage has a funny way of making mistakes much bigger.
Yeah it does, but it’s also nice seeing those gains explode. Just depends on how much you can take without losing any sleep at night. The great investors should be able to get about 3-4 hours
Naked puts is the only way I enter a position in my taxable account. I sell out of the money and if I buy the stock I buy it cheaper than when I first eyed it. If it stays flat or goes up I keep the premium and stay happy. I also limit myself to no more than 2x the underlying equity.
I’ll take either.
I don’t use margin (usually). If I see I’m about to be assigned many stocks I’ll take my losses and move on, but that hasn’t happen in a couple of years. Experience or luck
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