This will benefit those of you that are interested in contrarian investing the most, as I will post about stocks that are being crushed and giving my two cents on whether or not there could be a “critical point” in the future, that is, a point at which the stock will turn around and transition from being a dog to a Wall Street “darling”.
Just a few words of advice. Contrarian investing is risky. Even if you are right about a stock having strong chances of a turnaround in the future, you could still lose a lot of money if you do not approach your pick correctly. The steps below highlight ways to reduce the risk of loss and improve your chances.
1. Never go all-in. If you plan on investing $10,000 in a stock, make your initial investment no more than $5000. It is extremely rare to find the exact right moment to enter a position, so you should always use this strategy to accumulate a position instead of just jumping straight in. Let’s say the next day the stock falls by 6%. You would then still have the option of adding $1000 or $2000 to your investment. This is called averaging down, and it allows you to make up your losses quickly once the stock goes back up.
2. Stop-losses. I don’t like stop-loss orders. When you invest, you should be buying in because you have a thesis that you think has a high chance of being fulfilled (I’m not talking about day trading or technical trading. I’m talking about investing). Just because a stock drops by 8% on one day does not mean that your thesis has changed, and you should never panic. Averaging down will already help you deal with short-term losses. However, a stop-loss of some sort is always necessary, because you truly never know what could happen in the stock market or to your company, and taking a huge loss is never worth it. I would suggest looking at your company and estimating by how much it would go down if something truly went wrong that could affect it for the medium to long term. As a rule of thumb, you never want to lose more than 10% in a given day, as such a drop would represent a large problem that the market has identified. I would set a stop-loss at 8-10% below your buy-in price for a long-term hold type investment. Remember, as a long-term investor you don’t want to spend all day in front of your computer trading, so it is in your best interest to hold stable positions that don’t change day-to-day instead of day-trading for small gains and losses.
3. Always have a strong thesis. One of the biggest mistakes you can make is to purchase a stock just because it has fallen heavily recently and you think that “it has to bounce back”. Don’t do this. Really, just don’t. If you want to gamble you will have similar (if not better odds) playing roulette at a casino, and you will not look like an idiot if you fail there. No matter what the price of a stock is, your main reason to invest should be the thesis that you have built for what will happen in the near or distant future that the market does not yet see or believe in. A simple one can simply be based on a company’s value. If a stock has a down year, but you think that its products are unique and unbeatable and cater to a market that will grow, you have reason to invest in a stock. Having a strong thesis and investing in stocks that you believe in ensures that if the stock price sinks in the short-term you will not panic or assume a loss, as you will be comfortable holding the stock in the long term and ignoring short-term fluctuations.
4. Use limit orders. One way to improve your chances of buying in at the right time (or to decrease the odds of buying the moment before a huge drop or sluggish drop) is to set limit orders for all your purchases (that are above the current price of course, although only slightly). This really is a simple way of keeping your money safer. You will buy in as the stock price is rising, which improves your chances of a quick gain. Although you are investing for the long term, your thesis may change if you suddenly make 8% in one day, and you may decide to sell to lock-in profits.
5. Have a target. You don’t want to hold a stock forever (unless you want to live off of dividends, in which case that would be your target). Always have a price at which you believe that your thesis has either been fulfilled, or that it is no longer as significant to the price as before. If you really believe that the price will keep rising above your target, do one of two things. Either set a stop-loss at or slightly below your target, so that you gains are locked-in, but you can still speculate higher, or sell most of (at least half) you position and maintain a smaller position to speculate further.
These are my top four tips. Notice that I don’t cover how to determine if a stock is undervalued and how to make a technical analysis. You can easily find information for things like a P/E ratio or P/B by searching them up on Google. My advice is more personal and harder to find all in one place, and I hope it helps you become successful part-time investors!
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.