Three Basic Investing Rules
By Paul Goodwin, Cabot Analyst and Editor of Cabot China & Emerging Markets Report
Even at the highest levels, the most basic things are still the most important. If you’re looking for some inside trick that great investors use to make more money than the rest of us, you’re probably wasting your time. There’s a reason that the basics are the basics.
But if you want our opinion on the most important basic rule, the one that’s the equivalent of “keep your eye on the ball,” we couldn’t pick one…but we could pick three. And here they are.
1. Follow the market’s trend.
If you buy when the market is going up, you put the odds on your side, because a bull market changes the odds. It’s always easier to swim with the tide or run with the wind at your back. Stock markets are no different. And when markets are going down, you should work extra hard to weed out your losers and move toward cash for the same reason.
2. Cut your losses short.
When a stock starts falling, you have no idea how far it might go. The only theoretical limit is zero. And the longer you stick with it, the less capital you have to put to work. No matter how much it hurts—and it does hurt, we know from personal experience—you have to admit that you made a mistake and sell the stock when it reaches your sell point. We advise selling when you have a loss of 20% in bull markets and 15% in bear markets. But these are the absolute limits; we often sell at a 5% or 10% loss. Calculate the sell point when you buy the stock, write it down and stick to it. The number of times you get shaken out of a stock that then starts rising again will be more than made up for by the number of times you save your money to fight another day.
3. Let your winners run.
Some investors set buy points as well as sell points. When a stock is showing a 20% profit, or 25% or whatever, they will sell the stock and book the profit. But this approach makes it impossible to enjoy the wealth-building benefit of a stock that doubles and then doubles again, which is how really enormous gains are made. These big gainers, which reward you with compound growth, are what make aggressive growth investing a winning proposition. It takes just one of them to compensate you for a bunch of stocks that fall short.
There’s a reason that the same old rules are still the rules. Keep it simple. Keep your eye on the ball. And you’ll come up a winner.
More Portfolio Management advice:
How to Systematically Assess Your Risk
A "position sheet" will give you a great view of your portfolio's risk and rewards.
How to Handle Stock Losses
Losses are part of the process—it's vital to think of them in the right way.
The Importance of Stop-Losses at Earnings Season
Stocks can rise on hope, but a bad earnings report can do a Hindenburg on an individual stock.
Consider Taxes Before You Invest
When you consider the taxes before you invest, you'll have a truer grasp of your portfolio.
Seven Short Selling Tips
We don't have any official recommendations for short selling, but if you're determined to sell short, here are seven tips.
Investing Tip: On Selling Stocks
Selling a losing stock quickly can prevent you from having to deal with a much larger loss.
The Importance of Having an Investing System
Here are three ways the market is actively trying to take your money and what you can do about it.
Three Changes to Improve Your Investing
A successful small change is much better for you (both financially and emotionally) than a big change that you can't make happen.
Rules to Protect You as the Market Climbs a Wall of Worry
These three rules will help you manage your portfolio.
Year-End Portfolio Review Helps Set Goals for Next Year
Each year end, I review my investing strengths and weaknesses, examining stock charts of previous buys and sells, comparing them to market action, and so on.
How to Watch Your Stocks
Checking your stocks often probably doesn't do any harm, but it does reveal something about you as an investor.
How to Manage Risk during Bear Markets
The secret to surviving the bear market, of course, is adapting.
How to Plan for Stock Investing Risk
Successful investors always consider risk when analyzing their portfolio, adhering to rules like cutting losses short and diversification.
What to Do During Market Corrections
Our advice today, "Just Sit Tight," is little changed from our advice a decade ago.
Investing Basics: Keep your Eye on the Ball
Three rules: follow the market's trend, cut your losses short and let your runners run.
Identify Your Investing System and Stick with It
The hard part, in our experience, is sticking with your investing system.
Growth Stock Investing: Do You Want to Feel Right or Make Money?
Holding on to your losers while selling your winners may make you feel right but the best strategy is to cut your losses short while letting your winners run.
How to Average Up to Buy More of Your Best Stocks
Buying more of your best stocks can be dangerous if misused.
When to Sell Your Winning Stocks
What feels good to most investors is holding on to a big winner...and what feels bad is selling a big winner—but there are times when that's exactly what you should do.
The Importance of Managing Your Portfolio
Both professional and novice investors sometimes forget that the objective is to make money, not to own every good-looking stock in the market.