You may wonder why I would teach you how to use charts to make money in stocks, only to tell you that there really is more to it. Well, that’s only partly true. The following tips for investing in stocks are a refining of the buy low sell high strategy. They are meant to be used WITH IT.
Avoid Stocks in Financial Trouble
Buy-low-sell-high will only be effective with big enough companies that are going along fairly “normally.” The point of this strategy is to identify via a chart, what a stock is likely to do based on what it has done. If suddenly financial troubles or bankruptcy become an issue, a chart of how it did BEFORE it had these troubles is no longer a fair reflection of what is likely to happen in the future. Now you can make a small fortune trading bankrupt stocks. More likely you will lose your shirt .
For example, when the news about Enron broke, the stock price plummeted and then fluctuated wildly. I remember one day, after the stock was well under $1 per share, it rose over 30%. The next day it went up over 100% and then started nose-diving again. Sure, you could have made a bundle during that roller-coaster, but luck would be your only friend in that kind of investing.
Don’t Invest in Stocks that Just Go Down
It’s usually not that tough to find stocks that are low, but sometimes it’s because they always are! So view several time periods up to 10 years to see how the stock has done over the long-haul. You may decide to buy based on a one year chart, but make sure it isn’t just low because it always is. For example, I once bought Bethlehem Steel, before it went bankrupt and this is roughly what the ten year chart looked like:
Any 1-year time period might make this guy look like a good buy, but you’d be wrong. Looking farther back, you’d realize that this stock has done nothing but go down for the last ten years; not too promising. Let’s say I wish I had the current me to share these tips for investing in stocks with the past me!
Don’t Invest More than You can Stand to Lose
You may find the deal of the century and be tempted to max out your credit cards to buy it, but DON’T DO IT! There are tales out there about guys selling their financial souls to get into some “sure thing” and becoming millionaires overnight, but there are a lot more stories about very, very sad people that got to live like a homeless person for a while because they did the same thing. Unfortunately, you will learn that no matter how you invest, sometimes you will make a wrong decision. Not because the system is faulty, but because reality is not always entirely predictable. Remember, there are only two ways you can lose. First is to sell at a loss (which would be your fault, not the system’s). Second, the company goes bankrupt and your shares become worthless (but if you follow “the plan” this probably will never happen).
You also don’t want to invest more than you can stand to lose. Inevitably, you will need the money before you make money. For example, let’s say you invest your mortgage money for the month because you believe you found a good buy. Your plan is to sell before the payment is due, pocket the profit and pay the bill. What if the price goes down and stays there for a while? You still have to pay your mortgage and you will have to sell your stock at a loss to do so. If you don’t need the money you invest, then you can leave it in as long as necessary to see a return.
Don’t Put All Your Eggs in One Basket
I never liked this term because it means that you shouldn’t put all of your money in one type of investment, like stocks. It also implies that you should have some of your money as government bonds and cash. This is stupid, since neither will EVER make you much of a return. A better definition of this phrase is that you should invest in a number of different stocks instead of just one at a time. This is because you will be wrong sometimes. If you “put all of your eggs in one basket” and you are wrong, then you are up a creek. Then you will have to start all over at square one. So at any one time you might have say 10-20 different stocks. When you have more money to invest, use it to cut your losses. When you sell one, you start looking for another.
You might invest $100 or $10,000 at a time depending on your financial ability, it really doesn’t matter. But when you start out, you should concern yourself most with getting into a number of different “low” stocks rather than cutting your losses on just one or two. Once you have 5-10, then you can start cutting losses and getting into others. Truthfully, if you do it right, investing in even just a single stock at a time would probably work, but if you end up with a Lehman Brothers or Enron, then you will go bust. If you spread your money out, you can afford to lose once in a while.
Beware of Stocks Below $10
If a company sells 1M shares of stock at $100 each, it is the same as selling 10M shares at $10 each or 100M shares at $1 each. Does it really matter? Well, yes and no. There is no hard and fast rule about how “good” a stock is based on its price. Nevertheless, investment firms avoid stocks under $10. Larger, more stable companies know this and make sure their stock price is above $10. So in a sense, stocks above $10 tend to be more “stable,” even though it is not a hard and fast rule. You can actually make a LOT of money trading cheap, volatile stocks, but you have to rely more on luck than a proven, effective system like the one I’m showing you here.
NEVER Trade on Credit
This may be the most important of the tips for investing in stocks. Most brokerage firms offer credit, but it should be unequivocally avoided. If you borrow money to invest, Murphy gets free reign. Even if you make a good decision, you still have to pay interest as long as you hold the stock; this can eat into, or even cancel your gains when you sell. Additionally, if you invest a bunch of borrowed money into a stock and it goes down, you’re in trouble. But you could cut your losses, right? In theory yes, but if you didn’t have the money to invest in the first place, where are you going to get more to cut your losses with? Borrow again?
The only time that credit is a good idea is if you are trading “call” options. I won’t cover it here, but needless to say, if you do this you will simply borrow money to buy shares and turn around and sell them for a profit, so the “borrowing” you do is only for a few seconds or maybe minutes.
Don’t Invest in Your Emotions
Let’s face it, we are emotional creatures. It is difficult to avoid mixing feelings with investing. You almost can’t help but see the dollar signs in your eyes and just know the stock you are looking at is going to deliver retirement on a silver platter. Believe me, many people avoid stocks because they “tried” investing in them and went bust. Why? Because they used emotion to direct their decision-making. Maybe the initial choice to buy was even a good one. But once the stock went down a little, they got scared and sold out.
Every time I have invested using any amount of emotion, I have lost. However, every time I have followed my own rules that I am sharing with you here, and have made an informed, objective decision, I have made money. That’s why it is so important to do precisely what I have shared with you here. It works amazingly well, but ONLY if you follow the rules.
Use a Trailing Stop Loss to Sell
There are different preferences you can use when buying or selling stocks that, more or less, guarantee certain things. For example, you can execute a limit order to buy (or sell) at a certain price or better. There is also one called a stop-loss or stop-limit. This ensures that you will ONLY sell (or buy) if a stock falls to a certain price. For example, let’s say that you bought a stock a year ago that is up 30% and you are ready to sell. Since it is at a high, you fear it will go down soon. On the other hand, you don’t want to lose out on even more gains if it does keep climbing. A stop-loss will ensure that you ONLY sell if it falls below the target price you choose.
For example, let’s say your stock is at $36 (and you bought at $22). You set a stop-loss at $35. If it goes down to $35, you sell and lock in your profit. If it goes up to $37, you raise your stop-loss to sell at $36. Each time the price goes up, you increase your stop-loss. Effectively you are “following” the price as high as it will go. This way, you lock in your profits if the stock goes down, but make even more if it goes up. Of course this doesn’t guarantee that you will hit the high-EST price because it could slump temporarily, but you also protect yourself from a decline that might last much longer.