Buying a Stock? Do This Second!

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Buying a Stock? Do This Second!

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Buying a Stock? Do This Second!

There are hundreds of books written about what you should do before you buy a stock. Top investors love to do the research, the screening, the comparisons and every other kind of tea leaf-reading to measure a stock’s potential and the size of its possible gain.

I know that those of us who work the growth investing side of things here at Cabot certainly enjoy the stock selection process. It’s about as exciting as handicapping thoroughbred racing or picking teams for March Madness, but the gains are potentially much bigger. The better your research, the higher the probability that you can actually pick a winner.

But lots of people who do enormous amounts of research and pick really interesting stocks fail to do the next step. And it kills their results.

First, you buy the stock. Second, you … what?!?
Second, you set your maximum loss limits for the stock you just bought and you write it down on a sticky note where you can always see it!

I know that many people object to even thinking about loss limits just after they’ve bought a stock. Buying is fun. Buying is optimistic. Buying is exciting. Selling is a downer. Selling is admitting defeat. Selling hurts.

For many investors, spending time just after you’ve bought a stock thinking about where you will sell it if it breaks down is like shopping for a cemetery plot on the first day of your honeymoon.

Get over it.

The only valid reason for buying a stock is to make money. (I’ll make an exception for buying a few shares of a company that just hired your child or grandchild. Otherwise, no.)
And if there is one rule that is as widespread among growth investors as the Golden Rule is among the world’s religions, it’s to CUT LOSSES SHORT!

And the best way to keep your losses small is to take a little of that negative emotion out of the equation. Your rational mind knows that a majority of the growth stocks you buy will probably not deliver the performance you want. Either they will bog down and stagnate for months or they will roll over like dive bombers aiming to blow big holes in your portfolio.

Don’t let that happen. Take the second step. Multiply the buy price of your new stock by 0.85 to determine the 15% loss level. Then multiply it by 0.8 to find the 20% loss. Then write those numbers down on a sticky note and paste it where you can see it.

If markets are healthy, the 20% loss limit represents the maximum loss you can tolerate as your stock rallies and corrects. You don’t have to let the loss get that big, but you can’t let it get any bigger.

When markets are weak, use the 15% loss limit. Maximum.
If possible, don’t put an automatic stop into your online trading program. It’s too easy for a stock to dip lower during the day and trip your stop before rising again. These are best used as mental stops, though in-the-market stops are better than nothing.

If you can develop the habit of figuring these stop-losses and following them, you’re well on your way to becoming a true growth investor.

In this week’s Stock Market Video, Mike Cintolo describes exactly what he’s seeing in the market, both the bad, and also a surprising amount of good. More important, he goes in depth about what he’s seeing with growth stocks, what sectors are setting up, and exactly what he’s looking for in the days ahead to tell whether the market spills into a deeper correction … or whether some new leadership is about to emerge. Click below to watch the video.

Stock Market Video, Cabot Heritage Corporation

Here’s this week’s Fortune Cookie. Remember, you can always view all previous Fortune Cookies here and Contrary Opinion here.

Tim’s Comment: Five years ago, at the point of maximum fear about the U.S. economy, stocks hit bottom when the last seller had sold. That was an excellent time to buy stocks, but only the bravest, most independent, coolest-headed investors had the courage to actually do it. And way back in 2000, when the person who mowed my lawn and my barber were both dabbling in the stock market and fear was virtually non-existent, was an excellent time to sell stocks. But only the most cold-hearted and steely-eyed had the conviction to do it. Where are we today? Look around and decide for yourself.

Paul’s Comment: As I wrote above, avoiding emotional pain (by not selling your losers) is the mark of an investor who’s donating to someone else’s profits. When markets are rallying strongly, you need to keep a lid on your enthusiasm. And when markets are dredging the bottom of the canal, you need to be thinking like a buyer, not mourning like a loser.

In case you didn’t get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, there are links below to each issue.

Cabot Wealth Advisory 3/31/14 — 5 Commandments for Selling Short

Tim Lutts, the sage of Cabot Stock of the Month, writes in this issue about the five most important rules for selling stocks short, pointing out that shorting stocks is a high-risk business. Stock discussed: Bank of America (BAC)

Cabot Wealth Advisory 4/1/14 — April 1 Investment Opportunities

In this issue, I came up with content that was appropriate for the date, describing a few new ETFs that address previously neglected asset classes. Note: if you didn’t receive your Cabot Wealth Advisory on April 1, it may be because the humorous descriptions of hypothetical funds I wrote about contained some words that tend to set off spam filters. If you’d like to see the offending piece, you can click here.

Cabot Wealth Advisory 4/3/14 — How to Find Timely Stocks

Value expert Roy Ward, chief analyst of Cabot Benjamin Graham Value Investor, writes in this issue about using sector rotation across economic cycles as a guide to finding strong value stocks. Stock discussed: Michael Kors (KORS)

Sincerely,

Paul Goodwin
Chief Analyst of Cabot China & Emerging Markets Report
and Editor of Cabot Wealth Advisory

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