Five Reasons NOT to buy a Stock

There are several different strategies when it comes to stock picking.  While I prefer to find companies that have a great business that can grow for years to come, and then buy and hold those companys’ stock for years, there are other investing strategies that people make money using as well.  There are momentum investors who buy shares that are increasing in price rapidly and then hold on for a while, trying to sell before the stock falls out of favor.  There are also those who find the beaten up stock and buy and hold until it recovers.  There are also those who buy into sectors that are hot, or maybe buy into sectors that are ice-cold and then sell when they are hot.

There are also a lot of bad strategies.  Here are five:

1.  Buying a stock based on a tip from CNBC.  When a stock is touted by a TV show or in a business magazine, thousands of people are hearing that tip.  This means that before you can press “buy” many other people have already done so.  Stocks usually will jump up a dollar or two before you can do anything and then fall back within a month.

2.  Buy a stock because it is very popular.  Remember that the stock bubbles are based on the greater idiot theory.  Buy a stock because everyone is doing it and you may well be the greatest idiot.  This goes doubly for gold.  If peopel are talking about how great a stock is, it’s probably about due for a tumble (as a recent example, Apple).

3.  Go “all in” with a lot of money.  Your chances of being in negative territory increase a lot if you buy a lot of stock all at once.  For example, if you bought near the peak of the 1920’s, you would need to wait about 15 years before you were back to even.  If there has been a substantial swoon (think 2008), it makes more sense to buy a lot at once that it would after a long climb (think 2007), but you still run the risk of buying only part of the way down the slope(this is called “catching a falling knife”).  Instead, split the money and buy in increments.  Make the initial purchase, wait a few months for a dip, then buy some more.  You won’t hit the bottom, but you’ll generally do better overall than you will if you make a big purchase.

4.  Selling after a big downturn.  After an event like 2008, it is tempting to just throw in the towel and sell everything.  This is exactly the wrong time to sell, akin to locking the barn door after the horse has been stolen.  (Actually, it’s like burning the barn down!)  Most of the time the market is back where it was within a year after a big decline.  If you have the cash, buy more.  If you don’t, just turn off the financial news and ignore the market for a while.

5.  Buying on margin.  If you are buying stock on credit, you run the risk of losing more than you have.  You also face the risk of needing to sell right when things are down and you should be buying.  The extra income potential is not worth the risk for stocks.  It may not even be worth the risk for houses, as 2008 showed.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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