How Do I Get Started Investing?

How do I get started investing? Sometimes we don't even know which questions to ask first. Happily, others have already done some asking. Get answers here.

How do you qualify a stock to be in a certain category? For example: Emerging, small-cap, value stocks, etc.? 

Answered by Timothy Lutts, Chief Investment Strategist and Chief Analyst of Cabot Stock of the Month:
Emerging market stocks come from less developed, faster-growing countries. China is the most notable of these today; even though it’s now the second-largest economy on earth, its growth rate of roughly 10% means it’s substantially easier for companies to grow faster there than in the U.S. Number two on my list is India, which is growing at a rate of 7%, and number three is Brazil, which is growing at a rate of 5%.  Russia has the potential to be a powerful force, but is currently hampered by poor management. Up-and-coming countries to keep an eye on are Turkey and Indonesia. Traditionally, investing in emerging markets entails greater risk than investing in U.S. stocks, but as the liquidity of these stocks grows, and the dependability of their accounting statements grows, the risks shrink. Cabot China & Emerging Markets Report is your best source of advice when it comes to investing in these stocks.
Small-cap stocks are favored by investors who want their investments to grow faster, and know they can achieve that by investing in stocks not yet discovered by institutions. According to the table here—courtesy of Rick Wayman of Investopedia—a small-cap stock has a market capitalization of less than $2 billion … and I can’t argue with that. 

  • Mega Cap: Market cap of $200 billion and greater
  • Big Cap: $10 billion and greater
  • Mid Cap: $2 billion to $10 billion
  • Small Cap: $300 million to $2 billion
  • Micro Cap: $50 million to $300 million
  • Nano Cap: Under $50 million

I used to think $1 billion was the cutoff, but that was decades ago; things have grown since then. Wall Street loves to focus on big stocks, because that’s where the lucrative investment banking business is. And because institutions have to put large amounts of money to work, most can’t afford to even look at small companies. But if institutions stick to mid-caps and larger stocks, they’re only looking at 11% of the stocks that are available … which means there are lots of overlooked opportunities in smaller stocks. In Cabot Small-Cap Confidential the average market capitalization of the past 10 recommendations has been $128 million, ranging from a low of $19 million to a high of $305 million. 
Value stocks are inexpensive; that much is obvious. But by what measure? The amateur looks at price/earnings ratios, but they’re just one tiny piece of the puzzle. Professionals, like Roy Ward of Cabot Benjamin Graham Value Investor, look at much more. In fact, Roy looks at 44 separate factors, ranging from a firm’s current ratio to historical price/dividend ratio to quarterly earnings acceleration to price stability. Roy confines his research to very liquid large stocks that have proven management teams, and tries to buy them when they are out of favor.
Lastly, there are growth stocks. The ideal growth stock is one that starts out unknown, like Microsoft in 1986, and ends up big and famous, owned by thousands of institutions. But holding onto these stocks over multi-year periods, and through the big dips that come from time to time, is very difficult. With most growth stocks, we find it’s best to practice market timing, to invest aggressively when market trends are up, and then to move aggressively to cash when market trends are down. Cabot Growth Investor—our flagship—provides the ideal combination of growth stocks and market timing, and has been honored numerous times by Timer Digest and Hulbert Financial Digest for performance in up and down markets.

Why are earnings so important?

 Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
Companies are in business to make money. Thus, earnings are the ultimate score card. Companies that can grow their earnings rapidly and do it repeatedly see their stock prices rise to reflect their success. Conversely, companies that stumble on their growth path see the price of their stock fall. Investors are always looking ahead to what they believe the company's earnings will be in the future. Thus investors' perceptions of the company's prospects can be as important as the reality in the short term. But in the long run, earnings and earnings per share are most important.

More on earnings:
How to Handle Losses During Earnings Season
The Importance of Stop-Losses at Earnings Season Guidelines on Handling Earnings Gaps

What is a price/earnings ratio?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
If you divide a company's stock price by its earnings per share, you'll come up with a price/earnings ratio, or PE. This simple number reflects how well-thought-of the stock is by investors. A single-digit PE is considered to be low, while a number over 20 is considered to be high. If stocks were commodities, like bananas, a low price/earnings ratio would represent a bargain, a good value. But stocks are not commodities. A high PE simply confirms that investors believe a company will experience fast earnings growth in the future.

More on price/earnings:
How to Know Whether a Stock is a Bargain?

What is short selling?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
Short selling is the practice of borrowing shares of a stock so you can sell them, planning to buy them back later at a lower price, returning the shares and keeping the difference in price as your profit. In brief, you're betting that the price will fall. At Cabot, we do not recommend the practice, for a couple of good reasons. First is the long-term trend of the market, which has been generally upward over the decades, even centuries. When you invest (long) in a stock, you're investing in synch with the long-term trend. But when you go short, you're betting that the stock you're shorting will move contrary to that long-term, upward market trend. And you're betting that you're clever enough to time both your entry and exit points to catch this move. It's tricky. Equally important is the fact that the potential profits of a short-seller are limited. If the stock's price falls to zero, the best you can do is double your money. Contrast that with the potential of a fast-growing company that could triple your money, or more, in a year or two. Conversely, on the long side the worst you can do is lose all the money you invested in that stock, while if you're short, your potential losses are unlimited!

More on short-selling:
Seven Short Selling Tips

What is investing on margin?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
Someday your broker may ask if you'd like to invest on margin. In effect the broker is offering to lend you money so that you can invest it and profit from it. The broker is a guaranteed winner, because you pay him interest on the money you borrow and he gets the commissions when you trade with that money. But your profits will be harder to come by. You've got to pay that interest and those commissions . . . and your risk is increased. If you're doubled up on margin, for example, a simple stock drop of 10% will hand you a loss of 20%! And a 20% drop will give you a 40% loss plus a headache. In general, we don't recommend investing on margin.

What is market timing?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
We are strong believers in long-term market timing, mainly so we can sell stocks and preserve cash when the broad market enters into a major decline. This is not an exact science, but it can be tremendously rewarding to avoid losing money. And we've had great success with market timing over the years, so we feel confident in recommending that all investors practice it. On average, Cabot Growth Investor gives two major market timing signals per year. If it's a sell signal, we work to reduce risk by selling our poorest performing stocks and putting close limits on the others. The object is to reduce the risk of loss and to raise cash for the next buy signal, when bargains abound. When that buy signal comes, we invest aggressively in the best-performing stocks we can find. Interestingly, that's the time most investors are scared to death.

More on market timing:
Cabot Market Timing Indicators

Is it risky to invest when public sentiment is negative?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
To the contrary, that's the best time of all! The public, in general, tends to react to what has already happened and assumes that the past will continue. Investors have no way of seeing the end of a trend until it's well behind them. But we know that all trends end when the last holdout joins the crowd …when the last buyer buys or the last seller sells. The trend ends when sentiment reaches an extreme level. Then, because all the fuel for that trend is exhausted, the trend reverses. In general, the better you are at gauging the mood of the crowd, the more confident you will feel about buying when all about you have sold in panic…and moving to the sidelines when all about you are buying feverishly.

What are your top rules (or tools) for growth stock investing?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
My top tools for growth investing are:
  1.  Cut losses short (definitely rule #1 for growth stock investing),
  2.  Search for strong sales and earnings growth (especially triple-digit sales growth),
  3.  Search for revolutionary products with major benefits,
  4.  Heed the message of the overall market,
  5.  Never average down,
  6.  Be prepared for all contingencies (always have an exit plan ahead of time, just in case),
  7.  Never try to buy at the bottom or sell at the top (if you try to do it, you'll just lose money),
  8.  Stick with stocks that are liquid to avoid gut-wrenching volatility (usually at least 600,000 shares traded per day or more),
  9.  Only put more money to work after your past purchase or two is showing you a profit, and
10.  Be humble—making money in stocks is tough, so don't kill yourself over one or two bad trades, and be thankful when you hit a big winner.

More on growth investing rules:
Five Rules for Successful Growth Investing
SNaC: the Cabot Approach to Picking Growth Stocks
Three Basic Rules for Growth Investors

You recommended XYZ stock a couple of weeks ago, and today you're advising to sell it. How can you change your opinion that quickly?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
As Paul Goodwin (editor of Cabot China & Emerging Markets Report) has written a few times, you need to have three things for a successful stock—a good story (i.e., good future potential based on a unique product or industry upswing), good numbers (particularly strong sales and earnings growth and big profit margins) and a good chart (telling you deep-pocketed investors are accumulating the shares). Paul calls this the SNaC system—Stories, Numbers and Chart—and it's a useful acronym to remember. The most fluid of these three pieces is the chart—the story and the numbers don't change overnight, but in rare instances, the chart can (either positively or negatively). Most investors refuse to change their minds that quickly, but our studies show that a rapid change in the price of the stock—especially if it comes on earnings news—usually leads to more movement in the same direction. So if your stock collapses soon after you buy it, your best move is almost always to get out. Yes, it's painful ... but stubbornly sticking with the stock usually causes only more pain over time.

More on technical stock analysis:
Cabot Guide to Technical Stock Analysis

Business remains great at XYZ company, yet the stock is down significantly. Isn't it a good buy?  

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
The answer is generally no, and the reason is that a stock is not the company. A stock can fall sharply and persistently even if sales and earnings are growing quickly. That's especially true in a bear phase for the overall market. A good stock needs not only a good story and good numbers, but a good chart as well. One without the other two is far less reliable.

The CEO of XYZ stock, which you just recommended, just sold $2 million of his shares last week. Should I still buy the stock?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
Simply put, insider actions (either buys or sells) have never proven to be a great indicator of future price performance one way or the other. Sure, sometimes a stock tops out after the insiders dump shares, but just about all of the big-winning stocks in history have experienced plenty of insider selling as they rose to scintillating heights.What really matters is what institutional investors think of the stock—which is why we watch the chart.

Why is portfolio management important?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
While finding the best stocks in the market is obviously a very important aspect to making big money, it's just as important to know how to handle these stocks. Those who know how to handle them can made big money; those who don't can still make decent money. Broadly speaking, my top portfolio management rules are: 
1. Cut all losses short—if you do this, it's nearly impossible to get into serious trouble (assuming you're also adhering to rule #3, below).
2. Let at least some of your winners run—it's OK to take some chips off the table on the way up, but you want to give yourself a chance to benefit from a huge winner.
3. Don't risk too much—you shouldn't be risking more than 2% (preferably less than 1%) per trade. If you buy something at 50 and cut your loss at, say, 44 (a 12% loss)—a normal occurrence which is going to happen from time to time—you shouldn't lose a huge chunk (5% or 10%) of your total portfolio.  If you don't cut your losses short, you can quickly go bust during a rough patch in the market.
4. Don't risk too little—while you don't want to risk too much, part of your goal is to make good money when you do land a big winner.  If you only have 2% of your total portfolio in a stock, why bother? (You're not running a mutual fund.)
5. Follow the bottom line—too many investors fail to track their accounts. Big mistake! You don't need to follow things on a daily basis (in fact, that's probably counterproductive), but weekly or monthly tracking will help you stay on track and know when things go amiss.

What do you make of stock price reversals on earnings reports?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
In general, big down openings followed by higher closes are bullish, which bodes well for the stocks. But the bigger thing to remember is that decisive, powerful earnings gaps (up or down)—i.e., a 10% to 15% move through support or resistance on humongous volume—are meaningful. The most meaningful earnings gaps are the most obvious; if you see a stock move 20%, 25% or more on earnings, that move is likely to continue.
Many growth stocks have great sales and earnings growth, but also very high P/E ratios. Isn't their growth priced in?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
For growth stocks, P/E ratios are simply not an important factor in determining future performance. Rapid growth and (most important) a revolutionary product or service are better predictors. Eventually, valuation will matter, but you should let the stock tell you when it does—its own topping action will let you know it's time to move on. Just remember that a valuation is the result of good performance, not the cause of it.

What do you do when you buy a stock and get stopped out because it trips your loss limit, only to see the stock quickly reverse course and begin advancing again?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
This is a good question to think about because, frankly, such a scenario is going to happen a few times—that's life in the stock market. Here's what I would suggest: First, make sure you're buying properly; if you're buying a stock in the stratosphere, you're more likely to get shaken out on normal pullbacks. Beyond that, you should consider buying the stock back if it knocks you out but turns tail POWERFULLY. Remember, if you got shaken out, the odds are that many others did, too ... eliminating lots of potential resistance. So if the stock turns around, it could be ready for a nice upmove. I know it's psychologically difficult to do, but oftentimes, buying after a shakeout is one of the higher-odds investments you can make. So keep an open mind to it.

How do you handle stocks that announce new share offerings? 

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
More often than not, a strong leading stock will not break down because of a share offering, although such stocks usually decline on the news. And these stocks will often be "capped" in the short-term, until their offerings are out of the way. Just make sure you're buying because the stock truly merits your support, not because you're trying to get even. Really, though, it's best to just watch the stock's chart. If a stock announces a big follow-on offering and it breaks below its 50-day line, that's bearish. But if it pulls back but remains above support, it's usually worth holding.

What is your opinion about various stock-based indicators like MACD, RSI and Stochastics?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
Very good question. To be honest, I like to keep it simple—my charts just look at a stock's price history, volume history, a couple of moving averages (especially the 50-day moving average) and the stock's relative performance (compared to the market). All those "indicators" you mentioned are basically short-term overbought-oversold measures, which don't carry much weight with me. That's not to say they're totally useless, but if you're looking for intermediate- to longer-term profits, you want to know whether a stock is under accumulation or not. And MACD, RSI and the like don't help you determine that.

Should I use trailing stops?

Answered by Michael Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader:
A trailing stop is simply an order you place with your broker to sell your stock if it falls a certain percent off its high, or if it falls through a given price level. In general, I do believe stops are a good tool for the average investor. They will, first and foremost, allow the investor to cut losses short if his stock heads south after purchase. And they do help lock in profits should your stock, after a good advance, begin to break its uptrend. But as with all tools, the success of using trailing stops is based on the smarts of the user. Randomly placing trailing stops on a winning stock isn't a good idea; you can too easily get stopped out on normal fluctuations. I think the key to successful selling isn't having a blanket "sell anytime my stock drops 20% from its peak" strategy; the key is studying and understanding charts. If you're going to use a stop, put it somewhere that's technically relevant—having it just below the 50-day moving average, for instance, is a sound strategy. Or, if you're shorter-term, you might place it below the stock's lowest price of the past few weeks. Thus, I think stops are a good idea, especially if you can't watch the market and your stocks all day. But it's like anything else—if you put effort into learning the best methods to trail your stops, your results will improve.

More on seling stocks:
Selling Stocks: Your most important rule is cut your losses short

What is your policy regarding naming your paid letter's stocks in the press or in Cabot Wealth Advisory, your free e-newsletter?

Answered by Paul Goodwin, Chief Analyst of Cabot China & Emerging Markets Report:
Here's the rationale: When I'm called to do an interview, I don't have a list of second-class recommendations that I can deliver to the non-paying public. My watch list is my watch list. When the media asks me for recommendations, I feel that I have to give them the best stuff I have on hand. Occasionally, I may mention a stock that I'm watching for Cabot China & Emerging Markets Report but have not yet recommended ... but I can assure you that I'm not such a media star that it happens often. As for Cabot Wealth Advisory, we are careful to feature favorite stocks at least a month after we named them in the paid newsletter. And, of course, non-subscribers don't get the rationale, the buy/sell signals and the opportunity to ask questions.

Cabot stocks featured in Cabot Wealth Advisory:
Featured Stocks

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