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Maximizing Profits and Minimizing Risk
Not all your stock purchases will make out well. Perhaps not even a majority of them will make you money. But if you stick with stocks and sectors you know, youíll maximize your profits and minimize your risk. A good way to start is to focus on stocks that are closely related to your profession, expertise, and/or interests. Add to your knowledge by learning. Read. Take courses. Talk to experts. Try to develop an inside feel for the market.
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And even when the market seems to be going against you, stick with your game plan. Warren Buffett, the most successful investor of all time, never strayed from the companies and industries he knows best and believes in (such as razors and sodaóGillette and Coke), even when the market fell in love with high-tech companies. When the high-tech bubble burst, Buffettís investments stayed strong and his commitment to what he believed was vindicated.
Sticking to a good system is a lot harder than it sounds. You will be tempted to invest outside your area of knowledge frequently. Sometimes the stories will seem almost irresistible. Remind yourself: The better they sound, the worse they probably are.
And do the other conservative things that great investors like Warren Buffett do: Pay attention to the fundamentals, limit your ownership of individual investments, and be conscious of your goal in terms of time.
In analyzing every stock investment, ask yourself, ďWhat will this be worth in X years?Ē Remember, the reason you are investing in stocks is for medium-term (7- to 15-year) appreciation. If the stock isnít likely to give you a good return in that time frame, skip it.
I Donít Think You Can Predict the Stock Market, but If I Did . . .
The advice Iíve given you in this chapter will give you a solid foundation to invest in stocks safely and steadily. You donít need to read a half dozen magazines, subscribe to newsletters, and go to seminars. Just stick to one or two specific areas and be faithful to your system.
And forget about trends. Or try to.
If you simply canít resist trying to figure out the market, indulge yourself. But realize that what you are doing is nearly impossible. And keep the money and time you spend doing it to a minimum. Consider it a bad habit, like playing video games or smoking cigars. A little bit once in a while can be entertaining, but too much too often can be dangerous to your financial health.
That said, I have a two thoughts on predicting trends.
1. More often than not, it pays to follow the trend. Most of the big money Iíve made in business has come from enterprises that were riding the crest of a market trend. Although I am con-
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trarian by nature and enjoy reading contrarian speculations, Iíve never made any money by investing against the grain. I read somewhere that, at any given point in time, there is a 70 percent likelihood that an existing trend will continue for the short term. That is, whatís happening today will happen tomorrow. Although I canít cite the source, this is a statistic that feels correct. When you are investing in real estate or in a private business in an industry you know, itís not too difficult to get a feel for where in the trend you find yourself. Itís more difficult to make this judgment with stocks.
2. Your chances of figuring out your place in a stock trend depends on your knowledge. The better you know the industry, the better your chances. But with the stock market, you are dealing not just with business trends but with market psychology, too. Consider that bear markets always begin in good times and bull markets always in bad times.
SIX SENSIBLE STOCK INVESTING RULES TO LIVE BY
Here are a few rules of smart investing that you can bank on:
1. Most quick-buck deals turn out to be losers. If it seems too good to be true, it probably is.
2. Let your winners run ... and cut your losses short.
3. A rising tide lifts all ships. Whenever possible, invest in a sector that is appreciating.
4. A buy-and-hold strategy works only if you are investing in a solid company and can wait out a bad market almost indefinitely.
5. If you don't understand an investment, don't buy it. You will be at the mercy of your stockbroker and adviser. And they're never wrong, right?
6. There's no such thing as a hot tip. Getting inside information may seem like the next best thing to winning the lottery. But you could go to jail if you act on it. And if it's not the real inside dope, you could lose all your money.
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If You Were on a Desert Island and Had Only One Trend to Follow
The most time-tested market indicator comes from Charles Dow, who developed his Dow Theory in the late 1800s. He developed two market indexes, the Dow Industrials and the Dow Rails (now called the Dow Transports). Dow theorized that these two indexes represent production and distribution, respectivelyóand that when they are in agreement, the trend in the market is confirmed.