Buying individual stocks isn’t for everyone. For many people just investing through mutual funds and ETFs is the best option. Even if you do invest in individual stocks, you will likely have ETFs and index funds in your 401k or retirement account.

Buying individual stocks requires that you have an interest in investing. It also requires you spend a bit of time learning how to pick stocks, and then a bit of time researching the particular stocks that you are going to buy. There is also a little bit of record keeping that needs to be taken care of (but not a lot, really).

But there really is nothing like the thrill of finding a stock that becomes a “ten-bagger” (a stock that goes up 1000%, or 10x your investment). When you do that, it can make a significant impact on your financial life. There is also a community that surrounds individual stocks that it can be fun to be a part of. If individual stock investing is for you, your in good company. In today’s article, we talk about three secrets that will make your individual stock investing more profitable.

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1. Buy the company

Too many people get fixated on the price movements that individual stocks have. It is easy to see why: stock prices can change rapidly. When your stock goes up 100% in a few weeks or crashes and drops by half in a like amount of time, it can get your attention. Stock prices will seem to form patterns. Certainly there are levels off of which a stock’s price will bounce, called “floors” and “ceilings” by technical traders who try to model and profit from a stock’s price movements.

But most people will not do well by trying to trade stocks and time price movements. Just buying a diversified mutual fund and holding it will usually do better than trying to buy and sell a stock at just the right times. Really the chance of buying in at the right time or selling just before a fall is really low. Normally this is not worth doing.

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What does work? Becoming an investor in companies. If you find a stock who is able to grow earnings consistently over a long period of time, their share price will follow eventually. A company that has earnings growing by 15% per year will see its average share price also increase by about 15% per year. It might sit nowhere for a few years and then shoot up, or it might go up 100% in price and then sit for five years, but the share price will, on average, track earnings growth over long periods of time.

The first secret is therefore to look at the company and not the stock. Has it been able to grow earnings consistently? Do they have a good product line? Does management know what they are doing? Do they have room to expand into other markets or see other products? Look for companies that can grow and are likely to do so. Share price will follow.

2. Invest and hold

There are component two prices for an individual stock: The intrinsic price and the emotional price. The intrinsic price is what a company is worth based on the fundamentals: The earnings and prospects for future earnings. The emotional price is what people add or subtract from the price they are willing to pay for a stock based on feelings and emptions. Usually these emotions are fear and greed.

The intrinsic price can be calculated and quantified. For example, if stocks in a certain industry normally trade at PE ratios of 15 to 20 and a stock is making $1.00 per share, the intrinsic price would be from about $15 to $20 per share (earnings times PE ratio). The emotional price cannot be calculated and can be as big as the intrinsic price. The company above might trade for $35 or $10 is people are excited in the company or fearful of things to come. It actually might not have anything to do with the company itself, but what people feel about the economy, politics, world events, or other factors. Could just be that the CEO needed to sell a lot of shares to pay for his daughter’s wedding.

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The emotional price will tend to swing back and forth within relatively short periods of time. People might hate a stock for a couple of years, but then love it three years later. People may be scared of the economy in the fall and be raising cash, but then excited in the summer and buying shares again. The price for a stock will therefore center around the intrinsic price.

If you ignore the emotional price and just focus on the intrinsic price, which is much more predictable, you can reasonably predict what a stock will do long-term even if you have no idea what it will do next week or even next year. If you hold a stock long-term, you can therefore expect that there will be times when the stock is way up due to emotional price and times when it will be way down. But if you look just at the moving average price, it should be growing with the rate of earnings growth.

As long the intrinsic price is increasing, the price of the stock will be increasing long-term. This makes it much more likely that you will make money as a long-term holder than as a trader. You can even use the emotional price swings to get better prices when you buy and get more money when you sell. You don’t need to predict when they will occur, just act when they do.

3. Buy in quantity

The final secret is, if you’re going to buy individual stocks, buy them in quantity. This means don’t sit there with 10 or 20 shares. Not even 100 shares. You want to have 500 to 1000 share lots of companies if they are trading in the $10 to $100 range. You want a couple thousand shares if they are less than $10. If they’re up in the $500 to $1000 range, at least have 50 to 100 shares.

When you’re buying individual stocks, the whole point is to choose the better stocks and concentrate in them rather than spreading your money out among a lot of stocks. If you are going to spread money out, it is simpler to just buy index funds. Concentrating on a few companies allows you to choose just your best picks and really follow the companies and understand the businesses. It lets you really profit when you are right. You don’t want to make $2000 when your $20 goes to $40. You want to make $20,000.

That said, realize that concentration puts you at a much greater risk if you are wrong or if something simply happens to one of your companies. If you buy into a company and it falls due to a turn in business, it is entirely possible that it could never recover. Unlike an index fund, you can’t simply hold a stock forever and expect a recovery. All companies will eventually fail and never come back.

If you’d like to learn more about how to decide how much you should put in different types of assets, Sample Mutual Fund Portfolios gives lots of information and examples of how to make allocations for all sorts of different goals, including retirement.)

For this reason, limit how much you put into a single company to how much you are able to lose. If you have $200,000 to invest, you would probably not want to have $100,000 of it in one stock. But it might make sense to have $20,000 in one stock.

A general rule-of-thumb I use is to cut a position by 20% if it grows to 5% of my net worth. So, if you had a net worth of $1M, you might cut a position if it got to be bigger than $50,000 by selling $10,000 worth. The money you raised would be invested in another company or maybe an index fund. For me this is a nice balance between concentrating enough to make a difference when I am right about a company and letting my winners run, but protecting myself and locking in gains. Even if a stock totally falls apart, I’ll only lose 5% of my net worth.

Starting out, because it is easier to replace money that has been lost, your limits might be higher. For example, if you only had $10,000 to invest, putting $5000 in a single stock and $5000 in an index fund wouldn’t be unreasonable even though here you have 50% in a single stock. If you had a total loss on the individual stock position, you could probably replace the money from your salary in a year or so. If the stock doubled or tripled, however, it would allow you to grow your portfolio to $20,000 or $30,000 much faster than you could in only index funds. The potential gain is worth the extra risk you are taking.

Don’t know how to invest? Check out The Smallivy Book of Investing for a great primer. It gives you all the information you need to start investing and managing your wealth.

Have a question?  Please leave it in a comment.  Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmalllIvy

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..