5 Investing Mistakes Beginners Make in Bear Markets


5 Investing Mistakes Beginners Make in Bear Markets

Winds Blow Hard on High Hills

GoPro and Michael Schumacher


The past week brought a small flood of questions from readers asking how to handle the market's recent big drop. And some of these emails displayed a startling lack of knowledge about sound investing practices. This list is my small attempt to remedy that.

1. Know the difference between a value stock and a growth stock.

A value stock is one you own because it's cheap (not low-priced, but undervalued relative to its true value). One example today would be International Business Machines (IBM), recommended by Roy Ward in the latest Cabot Benjamin Graham Value Investor. When the broad market takes your value stock down a few notches-as it did to IBM-there's no cause for concern. You can still sleep well. You could even buy a few more shares. You know that eventually, investors will bid the stock up to its true value.

A growth stock, on the other hand, is one you own because the company is growing revenues and earnings (ideally) and the stock is going up. If the stock stops going up and starts going down, you should sell first, and ask questions later. For example, last week I recommended that readers of my Cabot Stock of the Month sell growth stock Salix Pharmaceuticals (SLXP), taking a profit of 38% (we bought in January). I'm still quite optimistic about Salix as a company, but that's irrelevant. Investors are now selling the stock, and I'm not going to argue with them.

2. With growth stocks, cut losses short. Ideally, you bought early enough and low enough so that you can now sell with a profit. But if not, that's reason to get out quicker. Sure, taking a loss means admitting you were wrong, but that's not a sin; I've been wrong hundreds of times over the decades. The sin is in being wrong and staying wrong!

3. With growth stocks, don't average down. Sure, it's tempting to reduce your average cost, but if the stock is going the wrong way, you shouldn't want to own more of it; you should want to own less. Averaging down is appropriate only for value stocks.

4. Don't try to catch a falling knife. Perhaps you were watching a hot growth stock like Mobileye (MBLY) on the way up, looking for an entry point, and now that it's down 25%, you see your opportunity. Don't chance it! The sellers are in charge now, and it's more likely to be lower a week from now than higher.

5. Sometimes it's okay to do nothing. Don't be an action junkie. And don't be in a hurry to try to buy in at the bottom. Once you've got your portfolio in a safe, comfortable spot, take a breath and relax.

6. Lastly, don't trust your instincts. Have a well-designed plan based on proven investing systems, and follow that plan. Note: if you don't have a plan you should probably read more Cabot advisories-maybe mine! For details, click here.

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Winds Blow Hard on High Hills

If I mention the name GoPro (GPRO), you probably know what I'm talking about. Or at least your brain refers to an image of what you think I'm talking about.

But when I mention Frontline (FRO) you probably don't. (I picked the stock at random, specifically for its lack of public visibility).

So when an editor at The Wall Street Journal or The New York Times or Google or Yahoo is deciding what stories to feature, what's he going to go with, GoPro or Frontline? The answer is obvious. He's going to give the people what they want.

Which is why my computer news screen shows me headlines like "Michael Schumacher's Brain Injury Caused By Helmet-Mounted GoPro," and not stories about Frontline's crude oil shipping business.

The headline with two high-profile names is going to get clicks. And the Frontline headline is going to be ignored.

So what does this have to do with investing?

Well, people have evolved to be social animals. They feel more comfortable when others around them are doing the same thing, whether it's cheering for a football team or drinking Pabst Blue Ribbon or chai lattes.

And when people invest, the same social instincts factor into their decisions. We feel more comfortable, more confident, if someone we respect also owns-or recommends-the same stock.

Which is one reason why a lot of investors piled into GoPro stock this year. They were the cool people at the party. They were excited about the future. And best of all, they were making money. The GoPro party (symbolized by its stock's ascent) was one of the very last ones still going on while the stock market slowly crumbled in September.

But as any celebrity will tell you, being famous is a double-edged sword. And when the going gets rough, and all those fair-weather partiers disappear, the media are only too happy to highlight the (alleged) darker side of the celebrity.

Thus the headlines about Formula One driver Michael Schumacher, who was wearing a GoPro-mounted helmet when he fell on some rocks while skiing last winter. (Obviously, his family can't sue the rocks, and ski areas and helmet-makers have learned to immunize themselves against lawsuits, but with GoPro factored into the mix, I can almost hear the lawyers calculating.) The story gets clicks, and that's what advertisers are watching these days.

Contrarily, if a Frontline tanker captain got drunk and fell off his ship, you'd probably never know about it. No celebrity, no notoriety, and no big money. If there was a story, who'd click on it?

Bottom line: the Internet is just a new player in the herding game.

But it hasn't changed the way the game is played. When you invest in growth stocks, growing popularity on the way up is wonderful-and you wish the party would last forever.

And when the party ends, bad news sells even faster than good news. Winds blow hard on high hills. Which is why the Schumacher/GoPro story, first reported in February (!) is now getting traction. Could there be more negative GoPro stories ahead? Of course.

If you're an investor in GPRO, you have a choice. You either dig in for the long haul and wait for the storm to pass (doing this requires a solid profit combined with a strong conviction that the company will weather the storm and come out stronger.)

Or you cash in your chips and wait for the next party to start, quite possibly somewhere else.

Note: GPRO was featured in last week's issue of Cabot Top Ten Trader.

Yours in pursuit of wisdom and wealth,

Timothy Lutts
Chief Analyst, Cabot Stock of the Month
Publisher, Cabot Wealth Advisory

Timothy Lutts can be found on Google Plus.

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