July 19, 2020
Note: nothing herein is investment advice. Spawner AI, Inc. does not provide investment, tax, or legal advice of any kind. This is not an offer, solicitation of an offer, or advice to buy or sell securities. Everything herein is for entertainment and educational purposes.
In part 1 of our mini-series, I spoke about where to begin researching for companies that have a high probability of generating healthy returns for your portfolio. Then, in part 2, I got my hands dirty and showed you how to apply this research methodology to stock trading by giving you an example using a mock company. By now, you should have a basic understanding of how to start investing. In this final part of our mini-series, I will talk about how you can fine-tune your investments and I will also provide you with idea snippets to broaden your tool sets.
At this stage you've invested in a stock and you are seeing it grow (we want to stay optimistic, but of course it could also be declining) and you are super excited and thinking about your next purchase from the returns. Before you make that decision, let us stop for a second and talk about another topic. When is the right time to sell? And even more important, should you even sell your position?
No one can time the market. Investors like to think that they can tell when the market will sell-off or when the market will embark on another rally. This is just not the case. If you are smart about investing you do not have to know when the next rally or when the next recession is. Warren Buffett, one of the most famous investors, has a saying that goes like this:
“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”
Personally, I do not agree with him since great returns can be made in less than ten years as well and unless you are investing for retirement there is no need to stay in a position for a decade. What I do agree with is that you must think long-term. When you put in the time and energy to properly research a company you should be thinking about investing for a year or even longer as short-term fluctuations do happen and by investing for a longer time period, these fluctuations can be smoothed out. A mistake I see a lot of people make, especially traders who are just starting out, is that they buy a few stocks that they are confident about and the first day there is a decline, they sell all their positions. WATCH OUT!
If you have done your homework, trust your hard work and stay in the position. A solid piece of advice for you you is to not even look at your brokerage account, as I know that it is stressful to see your hard-earned cash fluctuate so aggressively at times.
So going back to the question at hand, when do you sell? You have probably heard of the idea of a stock being overvalued. This just means that the stock price has increased compared to the actual value of the assets that the company has, and it is time for it to take a breather, therefore, it should decline. This is a natural cycle that we often see so there's little reason to panic. It is always a good idea to cut your positions once you have reached a nice profit let’s say a 10%-15% return. Even if there's additional room to grow, taking profits is beneficial to counteract potential impulse. I myself have caught my own impulse to hold several times, even when I made a 35% return. I kept telling myself the stock will continue going upwards, and sometimes it did! But locking in your profit is far better than losing it.
Famous investors like to say that investing in an index fund or a mutual fund is one of the best decisions you can make in the long run. If you are saving for your retirement, investing your money in an index fund such as the S&P 500 or the Dow Jones can be a good idea. If you have invested in these funds you do not have to sell them until you retire as the US market continues to rise (as seen in past data). Surely, we have recessions every now and then, based on historical data every four years, but in the grand scheme of things you could still turn a profit if you invest for the long-term (given the markets are in your favor).
A good idea is to follow the news on a daily basis to stay informed about global markets. You don’t have to read every news article on every platform. An example would be to read a market recap after the closing bell to see how the economy and the markets are doing. From these recaps, you can anticipate larger swings in the prices of the stocks you invested in and hopefully if there is another corona virus-like drop in share prices you can exit your positions before it’s too late.
If you decide to sell some of your positions, then you can start the entire research process all over again to find additional stocks that you can turn a profit from. The more research you conduct, the better you will become at it. As I have been doing this for a long time, I am always super excited when I get to embark on another research journey as this is where you can have an edge over other retail investors. Equity research is just as much an art as it is a science. It has basic principles that you should follow, but most of it is about finding the right way to value the companies. Newsflash: there is no right way to do since no one can predict the future with 100% accuracy.
As you undertake this exciting and rewarding journey of investing, you will learn from your mistakes which will be the best fine-tuning method there is. I've gone ahead and made a list of mistakes I myself have come across so that you can avoid them!
The most memorable and painful mistake I made was that I thought research is about examining charts and past performance. As I mentioned before, past performance does not translate to future gains. There must be an efficient and proper research methodology in place to find the best investments.
The second mistake I made for a long time was that I would look at my brokerage account non-stop and would get very nervous if the markets were going down. I started getting panic attacks and would immediately sell everything. This was a very bad mindset that most people unfortunately need to work past. Investing is a long-term game and even if there are larger losses in the short run, you have to keep pushing, always acknowledging that it might be time to cut your losses.
The final lesson that I learned through the years of trial and error was to be realistic. Whenever I would invest in a company and its stock would drop more than 10%, I would not exit those positions. I would tell myself that it will rebound, and I can exit the position once it is profitable. As you can probably guess, that was not always the case. To solve this problem I began utilizing stop-loss orders. With stop-loss orders you can set your risk adverseness, in this example let's say 10%. Once the stock drops more than 10%, your brokerage automatically sells your positions, hence limiting your losses and long-term risk.
There are dozens of other risks and mistakes that you can face when you start trading, but you can limit your risks by doing your research and always using common sense.
We have arrived at the final part of our mini-series and hopefully I was able to share my two cents with you so that you can avoid some of the mistakes that I made and become a better investor.
Stay tuned for other great articles from which you can learn more about investing and portfolio management!