What's Your Plan for Success When You Buy a Stock?
Great investments occur when opportunity coincides with planning. Here are six tips to better prepare your portfolio.
You've reached your free article limit
You've read 0 of 1 free Pro articles.
The vast majority of traders and investors have no clear plan when they make an investment. They read a little bit about a stock, do some research and since buying and selling is so simple and easy, they put a few shares in their account and hope it works out. In many cases, there isn’t even a clear holding period in mind. There is just a vague plan to hold on to it and eventually make some money.
In many cases it does work out just fine. In fact, there will be enough success, so planning doesn’t seem all that important. But there are times when it doesn’t work, and then you will pay a very hefty price for the failure to plan. One bad trade can wipe out months or years of profits when you sit and do nothing while an investment falls and never recovers.
One of the reasons that planning is ignored is that many people are seduced by the buy-and-hold mindset. They believe the way to get rich is just to buy a good stock and then hold it for the long term. It worked for Warren Buffett, so why shouldn’t it work for me? Sitting and doing nothing is a very appealing investing strategy, but it assumes that you are only buying good stocks. The truth about Warren Buffett is that he is a very active investor and ends up holding a very small number of stocks for the long term. He is constantly making plans and constantly dumps losing stocks and locks in big gains.
Winston Churchill once said that "plans are of little importance, but planning is essential." It is the process of making a plan for the stocks you buy that forces you to contemplate the many different things that can occur. The plans you make may end up being totally useless and will need to be adjusted as things evolve, but by engaging in the process of addressing surprises, you are better prepared to deal with them. If you never consider what you are going to do if your stock pick is a dud, then the likelihood is that you will do nothing or make an emotional decision that will make things even worse. Anticipating that your great stock pick may turn into a dud, you are better prepared to deal with it. As Taylor Swift wisely put it, “Just because you made a good plan, doesn’t mean that’s what’s gonna happen.”
The best approach to planning is to prepare for the worst, but hope for the best. Don’t let hope prevent you from preparing for the worst. I find it helpful to assume that every stock I buy has the potential to be a terrible failure, but I know that there will be a few that more than makeup for all the bad ones.
6 Tips to Better Prepare Your Portfolio
When making a plan for your stocks, here are some of the things you need to consider:
Time frame. The most important thing to determine when you buy a stock is whether it is going to be a trade, investment, or some combination of both. The biggest mistake that most investors make is to allow a failed trade to turn into a long-term investment. Rather than take a quick loss when a stock doesn’t act right, it is easy to just hold on and hope that it will eventually work out. It is essential to have a clear holding pattern before you can make any real plans.
Technical conditions. Charts are of great value, because they provide a framework for trade management. The goal is to cut losers quickly and let winners run. The best way to do that is to use levels on the chart to set stops or determine buy points. Buying a stock and then ignoring how the chart develops is a sure way to fail.
Fundamental conditions. Stocks are most often bought because they are viewed to be fundamentally superior, but fundamentals can be misunderstood or change quickly. There must be a plan to deal with a stock as fundamental conditions shift. If the company is growing strong, then you want to build on it, and if it is weakening, then it needs to be cut.
Market conditions. Market conditions will play a large part in determining how a stock will move. Many investors will hold their favorite stocks during poor markets, but market cycles create opportunities for both buying and selling. It helps to have a plan for what you will do with a stock that is suffering due to market conditions.
Accumulation. I believe the best way to build any trade or investment is incrementally. When you average in and out of a position, you will usually end up with a better average cost basis and reduce some of your risk. What is your plan for adding or cutting back a position as it goes through inevitable ups and downs? Ultimately, my goal is to make as much money as possible from my good picks while trying to limit the damage from my bad picks. To do that, I have to adjust position sizes continually.
Profit taking. What is the plan for taking profits? Do you just plan to hold the stock forever, or will there be a time when your capital can be used better someplace else? This may relate to your time frame, but all stocks have a limited life cycle. The period of great outperformance may last for years, but eventually, they will no longer be standouts. When do you start moving that money somewhere else?
There are many other issues that come into play when designing a plan, but the most important thing is to think about what you are going to do in the future as your precious investment moves up and down. Even long-term buy-and-hold investors must have plans.
