Often our own worst enemy to making money in the stock market looks at us in the mirror each morning. We do things we know we should not — for example, hold onto a stock that we know we should sell, hoping it will come back to even — because emotions get in the way of rational decision-making. It is time to take control of our emotions, logically evaluate positions, and make decision accordingly. It is time to stop playing around and time to get serious about investing.
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A strategy that has been created by this wishy-washy behavior is the use of a stop-loss order for positions that have done well. (Learn more about investing and stop loss orders here.) Here’s the scenario:
We’ve bought a stock that has done well, maybe climbing by 100% in a year’s time span. We look at the potential for continued gains but it seems like the stock has “gotten ahead of itself.” It would take three years for earnings to catch up with the current stock price.
Looking at the situation logically, one would sell the position. Even though this blog advises holding stocks for long periods of time, if a stock has gone up so far that the return for the next three years will likely be flat, it is time to sell. But because we think maybe the market will continue to push the stock up, we don’t want to sell out. We don’t want to be kicking ourselves after it goes up another 10%. (This is where the Wall Street axiom “Bulls make money, Bears make money, but Pigs get slaughtered” comes from).
So instead, we put in a stop-loss order a few dollars below the current price. We say, “If the stock begins to drop, the stop order will sell the shares for me and keep me from giving back my profit. If it continues to rise, I’ll just keep moving the stop price up and safely pocket the difference.” What we are really doing is being indecisive – avoiding the decision to sell and allowing the fates of the stock price movements to make the decision for us.
So what happens? Nine times out of ten the stock price will fall down to the stop-loss price and sell the shares. In doing so, we will be giving up a few dollars worth of price. If we had just sold the shares instead of playing games, we would be a few hundred dollars richer.
So, be a man (or a woman) and make decisions. Great investors are logical and emotionless. This isn’t about saving face or creating great stories for your cocktail parties. This is about growing wealth and gaining freedom. Take control.
Want to get started in investing, but not ready to pick individual stocks? Index fund investing takes very little time and is more profitable than individual stock investing done poorly. A great book explaining all of the ins-and-outs of index mutual fund investing is The Bogleheads’ Guide to Investing, which is a must-read if you want to start investing. They provide all of the rationale for using index funds, which buy a fixed set of stocks that essentially mimic the behavior of a segment of the stock or bond markets, instead of traditional mutual funds where a manager decides how to invest the money.
If you want to learn about individual stock investing, SmallIvy Book of Investing: Book 1: Investing to Become Wealthy is an excellent source of information. It provides information on many forms of investments, a strategy for investing that puts the odds way into your favor, and some tips on how you should be investing and managing your money during different stages of your life. The book provides a lot of the information you’ll need to know to do well in stock investing.
Have a good job but don’t seem to have money to invest? You need to learn how to take control of your cash flow and free up funds for investing. FIREd by Fifty: How to Create the Cash Flow You Need to Retire Early gives all of the details on how you can build a cash flow plan and free up money to build wealth.
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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.