With stocks, smart investors use a stop-loss order to automatically take themselves out of the stock with a small loss.
A stop-loss order is like insurance. For example, you pay your monthly insurance payment on your car. You don’t get upset at the end of the month because you didn’t have an accident. You bought the insurance to insure against the possibility you would suffer a major loss that would be financially devastating.
Selling a losing stock quickly by using a stop-loss order is the same thing as insurance. It is protecting your account from possible substantial losses that are difficult to recover from.
If you allow a stock to go down 50%, and then finally realize your mistake and sell it, you have to make 100% on the next stock just to get your money back. And 100% winners are not easy to find.
Automatically putting a stop-loss in after purchasing a stock helps remove emotions from investing. Once you buy and have your stop-loss order in place, there isn’t anything you can do. The market takes it from there.
Remember, with investing it doesn’t matter whether you are right or wrong; what matters is whether you make money. The market doesn’t care what you believe. You can either be on the right side of the market or the wrong side. That choice is up to you.
Too many people invest their whole life savings in a business, and empty their retirement account to fund a new restaurant or to open a retail store. These kinds of investments usually require tens if not hundreds of thousands of dollars to get off the ground, and unless you have been running a similar business successfully for many years, it is simply a very large risk to take.
Failure doesn’t always happen because of anything you did wrong. It could be that the marketplace changed, a huge competitor entered the market just when you did, the tax laws changed, the economy turned south, etc.
A good rule of thumb is to think carefully about any investment that, if it does not work out, would substantially alter your current standard of living and way of life. Would it put your current lifestyle in jeopardy? Your retirement? If it would, then you should probably not do it, or find ways to do it in a less risky manner.
A contrarian is someone who goes against the crowd. If everyone is bullish, a contrarian is bearish. If everyone is piling in to buy a certain stock, a contrarian is looking to sell it or short it (a bet that the price will fall).
You will by necessity need to be somewhat of a contrarian in order to be a successful investor. Some of the best winning investment strategies go against the pack. If you follow the crowd, you will be sure to lose in the long term. Think differently and do things that other people don’t do.
Though a contrarian correctly knows that the crowd is frequently wrong, and that the trend won’t continue forever, blindly taking the opposite side is a wrong assumption and can be costly.
The crowd can be right for a long time in the case of bubbles. Prices may move much higher before the trend ends. Just because something goes up a lot doesn’t mean it has to come down!
I learned this lesson well in 2005 when I watched the homebuilder stocks go up day after day. I knew we were in a real estate bubble that was going to end badly one day.
So I started shorting the stock of Lennar, a major homebuilder. Shorting involves making a bet that stock prices will go down. You can actually sell shares you don’t own and buy them back later, hopefully at a lower price than you paid. I won’t go into the technical details on how it works here, but it is a common technique.
Well, I would short Lennar, and it would just make a new high soon after. I would get out with a small loss, and look for another entry point.
I must have done this 6 or 7 times over a few months, each time losing a small amount of money as the stock seemed to defy gravity and logic, and kept going up and up and up.
Finally I gave up, tired of losing so many times in a row. It was over a year later that the stock finally stopped going up and began to fall. It went from over $60 a share to around $8 a year later.
Contrarian thinking is valuable. You need to employ it to make money with investments. If you only buy real estate when the market is hot and everyone is buying, you’ll end up buying at a high price. If you sell when everyone else is selling in a panic, you will sell at a low price.
If everything you read, or everyone you talk with agrees with you on where the stock market is going, or how great the real estate market is, don’t take this as confirmation you are right. Look at it carefully that you are likely wrong!
Why? Because with investing, when something hits critical mass with the public it usually means that the party is on its last legs. At the end of a run the market attracts the amateur investors who come late to the party after seeing it going on for some time. They finally can’t stand missing out, so they jump in.
It is at this point that the professionals and the smart investors, who invested early on, sell to the amateurs. The market usually tops out a year or so after the crowd enters en masse, and then falls.
Again, the crowd walks away at the bottom of the market, licking its wounds, and the pros and smart investors come back in to buy once again at low prices.
This scenario repeats itself year after year, in all markets. It’s based on human nature – fear and greed. The important thing to realize is that you must read and watch and listen so you know what everyone else is doing or focusing on, so you can use that information to your advantage.
Capital Properties
Nice content and tips that every investor can follow through it.