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The biggest mistakes people make when they buy or sell stocks are much bigger than the moment when they make them. In other words, it is not like missing a desired exit on the highway, but rather getting on the highway and driving without understanding where they are headed in the first place. How do you know how much gas you need? How do you identify the exit that you want? The biggest mistake that people make when they are investing is jumping in head first without conducting their due diligence. Below are a few of the critical elements to consider when buying and selling stocks.
Have an investment strategy: Are you driving a car, truck, bus, or motorcycle? What route are you going to take? Are you an investor or a speculator? Are you a day trader or a long-term type? Do you prefer fundamentalist value or technical trend trading? There is a lot to consider and understand before making the first move.
As a rule of thumb, investors look to preserve capital and see growth or income on their money. If you have a 401(k), a Roth IRA, trust you are probably an investor. Speculators are more like gamblers, they are playing the odds, trends and the bets that the numbers will go up or down. Speculators, alternately called traders, can reap incredible returns or go bust with a trade in a matter of minutes.
Long-term investing looks to buy stocks or assets that will hold their value and grow in price over the long term (years). The growth and size of the return can be much slower, but is also much more likely to be preserved when done properly.
Fundamentalist value looks at the balance sheet, income statement and cash-flow statement (the fundamentals of the company) before they consider buying a company. Essentially, they are looking under the hood to make sure the engine works well before thinking about buying a car. Technical trend traders look at the price and the price history. If the price gets outside of its normal trading range, then they make a move to maximize their money or minimize their losses. They do not look “under the hood” because they are less interested in the workings of the company itself than whether the company’s stock price is rising or falling.
Understand risk management: When entering the highway, a person will look to see what could potentially hurt her. Cars, trucks, buses, motorcycles, trains are all identified and evaluated to see if they could make her trip across the street end painfully. If you look while driving, why would you not look to see what can hurt you with a move into or out of an investment?
Risk management is very simple in concept, very critical to successfully buying and selling stocks but is the most over looked element of a good strategy in market. Risk management is not only about market factors; it is also about exposure. How much of a portfolio can be safely exposed to a single stock to maximize gain and minimize loss? That is a question for each to decide on their own, but we must understand that investing our life savings in the Facebook IPO could end very tragically. Conversely, investing calculated portion of our life savings in Facebook, could end badly, but would not be the end of the world.
Understand your investment: Know the status of the vehicle you are going to drive. A critical error in investing is not understanding how the investments work, people get into the most trouble when the wade into options, derivatives, futures, etc. without understanding the consequences of their action (see the opening sentences). Before placing a single penny into an investment, it should be clear what makes the investment go up in value and what makes the investment lose value.
Have an exit strategy: A final element critical to successful investing, is understanding when its time to part with a stock. Whether a trend trader or a value investor, both categories have their criteria for departure, and they both know what they are when the stock is purchased. A trend trader may plan to sell if the stock drops by 10 percent. A value investor may decide to sell when the debt-to-equity ratio of a stock gets above a certain ratio. Conversely, they both know what criteria they will sell at to maximize their profits as well. The point is that they have a contingency in place to deal with poor performance or excellent performance.
Remember, your money is at risk while it is in the market just like vehicles and passengers are at risk while on the highway. If you understand what your goals are, then you have a better chance to get enough fuel, dodge the other vehicles and get off at the right exits in achieving those goals.