You Weren’t There For The Wedding, Don’t Be There For The Funeral. This is an old horse racing proverb.
The ongoing credit crisis continues to caste an ominous shadow over the stock market and the light at the end of the tunnel is very dim.
However, there will always be speculation (including my own) so if you are involved in the market or planning to get involved, here are the top ten mistakes you need to avoid.
1.) Don’t Try To Catch A Falling Knife – If a stock is dropping, it’s not your job to save the company. If it’s falling hard and it’s falling fast, it’s falling for a reason.
Too many people make the mistake of thinking, “wow, this stock has dropped twenty dollars in value, I can buy it now and definitely make a quick five dollars.
WRONG. More likely, it’s still got a ways to go. AMBAC (abk) was at 96 two years ago. It’s now below 1. (As of July 25th, 2009)Let someone else save the day and pick the bottom. It’s okay if we miss the first couple of points if there’s really going to be a rally. If you try to catch a falling knife you will get hurt.
2.) Like The Book Says, Do What Wall Street Does Not What They Say – If you get in the habit of buying stocks because they are upgraded or selling stocks because they are downgraded then you’re probably developing a bad habit. You need to learn how to evaluate the stock for yourself. Not a full scale investigation of the company, simple steps such as monitoring the volume to look for a buying or selling pattern, recognizing support and resistance levels and utilizing key charting patterns. There could be a very good reason for downgrading a stock but it doesn’t mean that it’s going to move up big before it goes down or vice versa. When COACH (coh) got downgraded, I bought it and sold it 3 points higher. It eventually went down but not until after there was good money to be made in it.
3.) Don’t Trade Penny Stocks, Period! – Stop buying thousands of shares of a ten cent stock just because you can. the stock market is like life, you need to earn what you make by being consistent and doing the right thing. If you look for the easy way out (buy a bunch of a really cheap stock and hope it goes up) then you’ll probably start going in reverse and then the hole you need to dig yourself out of will be that much bigger. Sure, you can make big money fast every now and then but like life, you can win the lottery too. Do you want to risk your stock market venture on those odds?
4.) Remember That You’re Buying the Stock Not The Name – Too many people make the mistake of buying a stock because they recognize the name or like the product. That makes sense if you’re looking to buy it and hold it, forever! That’s not the strategy you want to go with, especially in this market. You need to get in the habit of making money and protecting your profits or limiting your losses. Just because STARBUCKS (sbux) makes great coffee (opinion) does not mean that you should buy the stock. They’ve been making the same coffee for a long time but the stock has ranged from over forty dollars in price to the mid teens. Your buy and sell decisions should be based on where the stock is and where it’s going to go.
5.) You Weren’t There For The Wedding, Don’t Be There For The Funeral – This is an old horse racing proverb. If a horse had won several races and you had never bet on it, but now you wanted to, the wise men who had been around horses for years would say, “You weren’t there for the wedding, don’t be there for the funeral.” You get the best odds and most bang for your buck at the beginning and it goes progressively down from there. Look at RIMM. The stock had been on fire. It got over one hundred and forty dollars in price. Everyone was making money in it until they weren’t. People lost thousands and hundreds of thousands of dollars because they bought RIMM between 120 and 140 in price. The worst part, when it hit 100 they continued to hold, HOPING it would come back. Now RIMM is below 80. They missed the wedding, they should have remained unattached. (As of July 25th, 2009)
6.) Don’t Buy Stocks Ahead Of Earnings – The allure of the stock market has always been and will always be the opportunity to make far more than you are risking. There should be a 5 -1 risk/reward ratio when you enter into a trade, not a 1 to 1. When it’s 1 to 1, you might as well be at a blackjack table. When stocks have earnings, the risk/reward moves from 5-1 to 1-1. This is because we are expecting a significant move in the price of the stock but we’re not sure which direction the move will be. Nobody is. If you had lunch with the CEO of a company on the day before his company had earnings and he told you exactly what the announcement would be, you still would have no idea how that announcement would influence the price or direction of the stock. There are expectations and motives that will cause the stock to move and these are separate from the actual earnings and forecasts. There are plenty of opportunities to capitalize after the news is out and the risk/reward is much better.
7.) A Buy And Hold Strategy Is No Longer A Viable Option – In today’s market, you are doing a disservice to yourself if you buy stocks and forget about them. With all of the variables coming into play (credit worries, oil prices, recession, stagflation) you need to take an active role in managing your money. This means protecting profits and even more importantly, limiting your risk. Placing stops below critical support levels will lower risk and give you the best chance for a profitable trade. Even if you do buy a stock and you are okay with it having a big drop because you “know” that in the long run, it will come back, how much of your money is going to be tied up in this stock, for how long and how much could you have made if you put that money somewhere else? You’re not a mobster so don’t forget about it, take an active role in managing your stocks.
8.) Being Diversified Can Hurt You – If the market is heading down then being diversified means you are increasing your chances of losing money. Think about it, if the majority of stocks are moving down then a diversified portfolio means that you are more likely to own stocks that are going down. Instead, you want to be trading individual stocks or profiting from the hot sector. By being specific and particular, you are navigating through a downward spiral and really taking strong measures to dramatically increase your chance of success.
9.) Expect The Best But Prepare For The Worst – Too many people enter into the stock market with high hopes. They have learned that you need confidence to succeed in life or they read The Secret. Either way, they have always been told that it’s better to focus on the good than the bad. That’s true BUT you need to be prepared for doomsday scenarios such as, “If this stock went to zero, would my life change?” If the answer to that question is yes then you have too much money in the stock market and you need to make changes. You should not trade stocks with money you can’t afford to lose. Your rent should not depend on the price of the stock. You should trade stocks when you have money set aside for that exact purpose and you know that this is money that you are looking to grow and snowball into something big but it’s also money that you are willing to risk. The stock market should only be life changing in a good way. There are no guarantees in the stock market and if anyone tells you otherwise, they are lying.
10.) Don’t Focus On The Money – When trading stocks, you can’t focus on the hundred dollars you made or lost or the thousands of dollars you could have made or should not have lost. If you get in the habit of focusing on the money then you will cut your profits short. Now, I know I just said to expect the best but prepare for the worst. Assuming you’ve done that then you are now trading with money set aside for trading. Now, stop focusing on the money. Just focus on the right and wrong of trading and the money will come. Learn from your mistakes, remember the good things you do so you can repeat them and focus on the right and wrong. This will allow you to eliminate emotion and take your trading to a much higher level.
Now, the key to avoiding all of these mistakes and the one thing you must possess to have any chance for stock market success is Discipline. In the stock market you will either learn the pain of discipline or the pain of regret.