Tip #1: Some of the best investments and trades of my career were totally obvious and if others had paid better attention they could have profited too from them.
For instance I usually never trade or invest in technology stocks but when the IPAD was introduced by Apple I immediately knew I might have a winner. The media derided the product as one that really didn't have a purpose and female reporters mocked the product because the name reminded them of a feminine hygiene product. I watched the over hour long Apple presentation about the product and was astonished. I watched it two more times and immediately knew apple had another hit like the IPod and IPhone. I then looked at the company's fundamentals and found it very attractive. They had no debt, $60 billion in cash and marketable securities. They traded at only ten times earnings when earnings were growing at 30% plus. Unlike most technology stocks that trade at four or five time's revenue, they were trading at 2.25. I figured a company like this was worth three times revenue so with the stock trading at $210, I thought it could be worth $275. As we know now the stock eventually traded over $700, so this proves that one of the most obvious trades around was sitting there undervalued and unappreciated for months at a time. This was one of the few times in my entire career I bought a technology stock and while it paid off handsomely, I will admit I misplayed one of the best opportunities of my entire career.
Tip #2: Supply and Demand for shares in the end is what determines the actual direction of stock prices.
You have to understand that the real forces which set stock prices in the very short-term are supply and demand just like with any other product. If the demand for a company's stock exceeds willing sellers at the current price, the price will move higher to induce additional sellers. If there is insufficient demand at the current price, the price will move lower in order to induce additional buyers. The stock market in this sense is just that, a market of buyers and sellers who come together and agree on prices. If you just understand this simple concept you have an advantage over other investors. They think there are other more mysterious forces at work when in reality that is what governs prices in the very short-term. The financial media adds to this because every day they try to report a reason or news item for why the market went up or down. This is a reason that emotions affect the volatility of the trading of stock prices. If you understand this concept it also gives you a much better understanding to have better insight from technical analysis which I will talk more about later.
Tip #3: When you enter a trade or an investment you need to have a plan.
Your plan should include why you own the stock. You should have a price target in mind of when to sell the stock if it is a winner. Just as important you should have a plan to exit the stock at a certain percentage loss to protect your capital. Many traders advocate placing of automatic stop orders to sell if a certain price is reached. I don't normally do that because a signal news event that causes a shock could cause you to be stopped out on your entire portfolio at prices much lower than your stop prices. However if you have difficulty cutting your losses placing of automatic stop orders should be considered.
Tip #4: Trading and Investing is a marathon and not a sprint.
It is easy to get bogged down on your current trading results or your last trade. However trading and investing is a marathon and not a sprint. You will execute hundreds of trades and make thousands of decisions over a period of years. If you just keep this in mind even when you have a string of bad trades and you will have losing streaks, you have to step back and look at your longer-term results. Again human beings are emotional by nature and nothing is as emotional as profits and losses.
Tip #5: Never let a profitable trade turn into a losing trade.
If you become profitable on a trade and it starts to reverse you have to take profits on say half of your position. You never want to let a profitable trade turn into a losing trade. It will hurt you emotionally and cloud your judgment. One of my first stock trades was up 25% and because it went my way so quickly I had a higher price target in mind. It then fell all the way back below my cost and I was stuck in the trade for a year and wound up only making a small profit. If I had sold half or even two thirds of my positions, even if the remainder of my position had pulled back to my purchase price, I would have been able to make a better decision and would have been profitable on my entire position overall. The reason this is even more important is the fact you had a nice profit will make it even more difficult to sell and take your loss and the emotional toll on your confidence is awful.
Tip #6: When you make a purchase or sale it shouldn't be an all or none decision.
In other words you don't have to make your initial purchase or your subsequent sales all at once. That is called the sin of arrogance because you're saying I know that this price is the right price. So I might make two purchases to create a position and if it goes profitable, I will sell half and then let the stock price determine my second sell. If I have significant enough profit and it meets my plan I might just go ahead and sell my entire position. My point is that most investors make all or none decisions which makes it more overwhelming to make the right decisions. When trading you're going to have winners and losers, the goal is to make your winners significantly more than your losers and then your ratio of winning to losing trades has less impact on your overall results. As you will read in other secrets there are two exceptions to this rule, never continue to add to a losing position more than once. Also if you're selling to cut your loss to protect your capital, you should just sell your entire position to avoid the potential of further losses. You will find when trading sometimes you have to take a monetary hit short-term in order to keep you in a positive mental balance. That is so when the next opportunities arise you aren't stuck in losing trades and have a bad emotional state that prevents you from future profits.
Tip #7: Never add to a losing position by buying additional stock more than once!
When I purchase a stock that then falls lower than my purchase price, I will only add to my position by buying more of the stock once. I will do this to lower my average cost of my position, so for example say I buy a stock at $41.50 and if it falls, I buy another at $40.85. First of all, this is the way I planned my purchases so my goal was is to accumulate a 10% position at an average cost of the two purchases. After both purchases, then my new average cost is now $41.18. The reason you never add to a losing position again is if the stock then fell to $40, I would have a 2.86% loss ($40/$41.85-1). If my loss in a stock exceeds 3%, I become concerned and if it falls below 4.5%, I always immediately sell and take my loss. Managing your losing trades is actually more important than managing your winning trades. This is in order to protect your capital from a huge loss. I will get into more about that later but say I just kept adding and the stock continued falling and the next thing I know it is $38. In this same scenario, if I bought another 5% at $39 I would then have a larger 15% position, with an average cost of $40.16. So if I sold the same 15% position at the same price of $38, my loss is much higher 5.38% and it my position size is 50% more. So I would have doubled my loss just because I couldn't admit my mistake! Some people say when a stock you buy goes lower: "Don't frown, just average down!" However that is the worst advice possible because in reality you should: "Don't average down, sell and minimize you frown!"
Tip #8: Managing your stock or investment portfolio is like tending a garden.
With your stock portfolio you need to treat it like a garden. You want to water the vegetables and pull out the weeds! This is another very simple concept. You want to sell or remove the weeds which are stocks that are losing money or aren't performing as planned. Losses are like weeds, once they take hold they drain resources and multiply rapidly. Your vegetables are your profitable stocks. You want to nourish them with fertilizer and attention. Like vegetables you also have to harvest them or if you wait too long (get greedy) they will take back what they have produced. By removing the weeds (minimizing losses) you also free up new ground for better ideas with potential of producing good fruit. The weeds also sap your attention and resources that can be devoted to your productive vegetables. This is a constant process and if you approach it that way, you're already trading and investing like a professional does. Many people do the exact opposite! They sell their winners too soon and hold onto their losers in hopes their weeds will mutate into a vegetable. Hope is not an investment strategy and it is a losing one, so don't do it!
Tip #9: When you have a losing trade, admit you made a mistake and move on!
This is one of the hardest things for individual investors, traders and even some professional money managers to do. The reason it is difficult is found in your brain, specifically your ego. After researching a stock and deciding it offers an opportunity to profit, you make the decision to risk hard earned money and purchase the stock. You're a human being and not a computer so know you have a personal emotional stake in the outcome. When it goes your way and you profit it is fairly easy to think rationally and not do something stupid. However when a trade goes against you, you will only focus on taking a loss. Your emotion and especially your ego will prevent you from doing the right thing, selling and cutting your loss. The sooner you admit your mistake and take your loss, the sooner you can prevent further losses and move on to better opportunities. There is a mathematical reason this is essential. Logic would tell you that if you take a 20% loss, it would take a 20% gain on a subsequent trade to get even. That is actually incorrect since your $100 is now only $80, for that now reduced $80 to return to the original $100, you have to make a 25% gain which is actually a 25% larger gain than your original loss. The larger the percentage you lose, the worse the numbers get. If you take a 40% loss, it takes a 66% gain to be back to even. If you just understand this one concept, it will keep you much more disciplined about accepting your losses. This will keep you around and in the game when others lose huge and leave never to return.
Tip #10: Emotions can be your biggest enemy or ally when trading.
As you can see your emotions can be your biggest enemy when trading. Since you're human there is no way to remove them from the equation but over time and thru experience, you will get control of them or you will get run over. Now that I have written about so many negatives let's get to some positives and some secrets that will make you money instead of minimizing losses. The same emotion that drives other investors and traders in a negative way is what you can harness to put profits in your own pocket. If others have overreacted to an event or news, you can take advantage of that for a short-term profit. This is difficult because you have to judge when a psychological threshold is about to reverse and that takes experience of actually watching it occur to become proficient at it. The fact is that every day a stock that trades in a 2-3% range, that demonstrates the emotions involved in the buying or selling of securities. If emotions weren't involved in the trading of stocks, why would the perceived value of a company fluctuate 2-3% in a single day or more based on no news or even a rumor?
Tip #11: The stock market is actually 75% psychological and only 25% based on fundamentals and logic.
Most investors, financial professionals and even the financial media assume the stock market is based on fundamentals and is logical and rational. However in reality it actually is 75% based on psychology and only 25% fundamentals and logic. The simple reason for this is that the decisions about purchases and sales are made by humans. Human beings are emotional and not usually logical and rational. The two emotions that drive the stock market are greed and fear. Those are two powerful emotions and can cause almost anyone to make bad decisions. The emotions are what dominate the short-term trading of stocks while the fundamentals are what govern the longer-term rise or fall of prices. This is one reason that If you can use the left and right side of your brain and mix understanding people and emotions with logic and reason, you can have above average results. In my case I have a right side logical thinking brain. However because I was also trained in technical theater and exposure to the arts, I also developed the left side of my brain which is more creative and emotional. Therefore I have a better understanding of emotion and people; the combination of the two is very powerful in the stock market. I can't prove this but I strongly believe that a significant majority of the most famous and extraordinary investors have two traits; the ability to use both sides of their brain which allows them to think outside of the box versus someone who is dominate by either side of their brain.
Tip #12: Trade and invest in companies that you understand!
Warren Buffet and Peter Lynch who are two of the most famous successful investors in recent history adhere to this motto. Warren Buffet likes to buy stocks and businesses that are simple to understand, have strong brands, high barriers to entry for competitors and then hold them and hold them for very long periods of time. This has led him to being one of the top five richest people in the world. Peter Lynch who ran Fidelity's Magellan fund and racked up spectacular gains versus the S+P 500 index, always said that if you can't explain what a company does and why you like the stock in one minute, don't buy it! He spent more time at the mall and fast food restaurants looking for new stocks to buy than studying charts and listening to analysts. Both of these investors almost always avoided technology stocks and growth stocks for these very reasons. To give you an example right now I favor companies like retailers, railroads, casinos, industrials, asset managers, airlines, natural gas and restaurants. I understand those businesses, like the valuations and until a significant majority of other investors drive up their prices, I will continue to trade them.
Tip #13: Fundamental analysis focuses on the mathematics and logic while technical analysis examines the relationship of historical prices, psychology and the emotions involved in the trading of the stock.
Fundamental analysis focuses on fundamentals of companies in relation to their stock price. Investors look at the price to earnings ratio, price to book value, revenue and earnings growth rates and dividend yield. I have to be comfortable with the fundamentals of a company before I choose to trade or invest in it. Once a company has passed this screen, I then look at the technical analysis. Technical analysis is basically looking at charts of recent price and trading volume of a stock. The best description I have heard it compared to is like an electrocardiogram (E.K.G) of your heart. It shows you the trend and how volatile the trading of the stock is in general. The most important thing is that it is a window in the psychology and emotions of the trading of the stock. However the flaw in both of these methods of analysis is that they are based solely on past historical information. While that is relevant to the future it only assists you in making educated guesses about the future direction in prices. It can usually only improve the accuracy of your predictions but an educated guess is still just a guess. Some investors believe they should focus almost exclusively on fundamentals or technicals and personally I'm about 65% fundamental and 35% technical. Your experience and personality will lead to one or the other governing more of your decisions.
Tip #14: Flexibility and the ability to change your mind when the facts change are some of the most important abilities to being a successful trader or investor.
To give you an example, say I have traded a certain stock four times in a certain range and been profitable all four times. There will inevitably come a time when that trading range changes and I have to take a loss to minimize my loss. More importantly it will free me from that loss to come back to the stock when it has established a new trading range. Or when the stock has new positive news and it breaks out of that range, I might then buy the stock higher than the range I previously traded. The worst case is I'm in the stock, negative news is released and it drops quickly. Since at that point, the facts have now changed I need to adapt, admit my mistake and sell and move on. The great thing about the stock market is that as long as you protect and have your capital, there will be dozens of new opportunities to make gains, get back your losses and continue to profit. So as you can see being flexible in your strategy, adapting to changing market environments and news is what separates the professionals from amateurs.
Tip #15: The real key to trading and investing is to make judgments about the general consensus that is priced into a stock currently. Once you can estimate what is currently priced into s security, you can make guesses as to what effect on price certain new or catalysts might have.
I look for situations where other investors might be unaware of a potential positive catalyst that might change a company's fundamentals. Or certain assets the company owns that are undervalued and unappreciated. It is king of like looking at the betting line on a football game. If a team is favored to win by 8 points and I think the probability is more like three, the trade could be promising. So basically I'm looking for situations where the stock price could be poised to beat the expectations of the consensus of other investors. This is a difficult concept for most investors to understand and more difficult to apply. That is because you have to try to guess what other investors are thinking. However the stock price is the clue, you can compare it to others in the same sector, to various valuation metrics, the consensus opinion of analysts and look for pricing inefficiencies. For instance when I like a certain sector, the company considered the best company in the sector is usually always valued too highly. So my prospects with the most potential candidates are inevitably the second, third or fourth out of six to eight stocks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.