The Three Most Important Investing Lessons
By Timothy Lutts, Cabot Chief Investment Strategist and Editor of Cabot Stock of the Month Report
From Cabot Wealth Advisory 11/6/09 Sign up for free Cabot Wealth Advisory e-newsletter
"Give a man a fish; feed him for a day. Teach a man to fish; feed him for a lifetime."
The saying is good. It's hard to argue with it. And recognizing that, I'm going to spend today's column not giving you a fish but teaching you how to fish ... for successful growth stocks. I'm not going to try to do it all in one column; that would be foolish. You can't learn to fish in one day, either. But I'm going to focus on what I believe are the three most important lessons.
Lesson #1: Cut Losses Short.
No one picks all winners. Even the best growth investors see at least one-third of their stocks go the wrong way. But these investors succeed because they keep their losses small while allowing their gains to get larger. They know that if a stock isn't doing what they hired it to do, they should probably fire it.
On the most basic level, you've got to remember the importance of preservation of capital; if you lose it, you can't invest it. One of the best ways to minimize losses is to buy smart, when chart patterns tell you the odds of upside movement outweigh the odds of downside movement. You can determine these set-ups with technical analysis. But even the best set-ups sometimes fail; there are no perfect investing systems. And that's why the #1 rule for growth-oriented investors is to cut losses short.
Lesson #2: Respect the Market Trend.
No investment exists in a vacuum. Every stock exists as part of the larger stock market and thus is subject to the ebb and flow of the whole ... and you ignore it at your peril. When the market trend is up, most stocks will rise, driven not just by improving fundamentals but also by an increasing sense of optimism among investors. Contrarily, when the trend is down, most stocks will fall, and if you attempt to swim against the tide, you may drown. Many investors get too caught up in the merits of their particular stocks, convincing themselves these stocks are so wonderful that they are immune to the effects of the market. And they are frequently proven wrong. I'm not saying you have to know what the market's doing every day; it doesn't pay to get too close to it. But you should definitely have in mind a picture of the market's main trend ... and invest accordingly.
Lesson #3: Beware the Consensus Opinion.
This is the hardest lesson of all. Most of us feel comfortable when we hold opinions that mirror those around us. To be a successful investor, however, you've got to think differently. Ideally (and the ideal is impossible to achieve), this means buying a stock at the point when the maximum number of people is trying to get rid of it ... thus getting the lowest price. And it means selling your stock at the point when the maximum number of people is trying to buy it ... thus getting the highest price. To act that contrarily to the masses is difficult, and only possible if you continually question the common wisdom.
For example, Apple (AAPL) has grown into a well-respected company in recent years, thanks to wonderful marketing, customer service, leadership and--above all--products. (I love all my Apple products.) As a result, Apple's stock has done very well. But Fortune Magazine just put Steve Jobs on its cover, naming him CEO of the Decade, and to me, that's one more sign that AAPL may be near the end of its run.
Click here for more information on Cabot Stock of the Month.
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