Three Basic Investing Rules

By Paul Goodwin, Chief Analyst, 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.

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