Knute Rockne, the famous winning Notre Dame football coach, used to say, “Build up your weaknesses until they become your strong points.” The reason people either lose money or achieve mediocre results in the stock market is they simply make too many mistakes. It’s the same in your business, your life, or your career. You’re held back or have reverses not because of your strengths, but because of your mistakes or weaknesses that you do not recognize, face, and correct. Most people just blame somebody else. It is much easier to have excuses and alibis than it is to examine your own behavior realistically.
When I first wrote this book, I came across lots of people who were advising: “Concentrate on your strengths, not your weaknesses.” That sounded logical and reasonable in many situations. But now, after 50 years of day-today experience in America’s amazing stock market, where every cycle thrusts forward dozens of brand-new, innovative, entrepreneurial companies that keep building our nation, I can state this:
By far the greatest mistake 98% of all investors make is never spending time trying to learn where they made their mistakes in buying and selling (or not selling) stock and what they must stop doing and start doing to become more successful. In other words, you must unlearn many things you thought you knew that ain’t so, stop doing them, and start learning new, better rules and methods to use in the future.
The difference between successful people in any field and those who are not so successful is that the successful person will work and do what others are unwilling to do. Since the early 1960s, I have known or dealt with countless individual risk takers, from inexperienced beginners to smart professionals. What I’ve discovered is it doesn’t matter whether you’re just getting started or have many years, even decades, of investing experience. The fact is, experience is harmful if it continuously reinforces your ongoing bad habits. Success in the market is achieved by avoiding the classic mistakes most investors, whether public or professional, make.
Events in recent years should tell you it’s time to educate yourself, take charge, and learn how to handle and take responsibility for your own financial future: your 401(k), your mutual funds, and your stock portfolio. These events include Bernie Madoff’s theft of billions from supposedly intelligent people through his supersecretive operations, which were never transparent, as he never told anyone how he was investing their money; the public’s heavy losses from the topping stock markets of 2000 and 2008; and the use of excess leverage by Wall Street firms that couldn’t even manage their own money with prudence and intelligence, forcing them into bankruptcy or shotgun weddings.
You really can learn to invest with intelligence and skill. Many people have learned how to use sound rules and principles to protect and secure their financial affairs. Here are the key mistakes you’ll need to avoid once you get serious and make up your mind you want better investment results:
1. Stubbornly holding onto your losses when they are very small and reasonable. Most investors could get out cheaply, but because they are human, their emotions take over. You don’t want to take a loss, so you wait and you hope, until your loss gets so large it costs you dearly. This is by far the greatest mistake nearly all investors make; they don’t understand that all common stocks are speculative and can involve large risks. Without exception, you should cut every single loss short. The rule I have taught in classes all across the nation for 45 years is to always cut all your losses immediately when a stock falls 7% or 8% below your purchase price. Following this simple rule will ensure you will survive another day to invest and capitalize on the many excellent opportunities in the future.
2. Buying on the way down in price, thus ensuring miserable results. A declining stock seems like a real bargain because it’s cheaper than it was a few months earlier. In late 1999, a young woman I know bought Xerox when it dropped abruptly to a new low at $34 and seemed really cheap. A year later, it traded at $6. Why try to catch a falling dagger? Many people did the same thing in 2000, buying Cisco Systems at $50 on the way down after it had been $82. It never saw $50 again, even in the 5-year 2003 to 2007 bull market. In April 2009, it sold for $20.
3. Averaging down in price rather than averaging up when buying. If you buy a stock at $40, then buy more at $30 and average out your cost at $35, you are following up your losers and throwing good money after bad. This amateur strategy used in any individual stock could produce serious losses and weigh down your portfolio with a few big losers.
4. Not learning to use charts and being afraid to buy stocks going into new high ground off sound chart bases. The public generally thinks a stock making a new high price seems too high, but personal feelings and opinions are emotional and far less accurate than the market. The best time to buy a stock during any bull market is when the stock initially emerges from a price consolidation or sound “basing” area of at least seven or eight weeks. Get over the normal human desire of wanting to buy something cheap on the way down.
5. Never getting out of the starting gate properly because of poor selection criteria and not knowing exactly what to look for in a successful company. You need to understand what fundamental factors are crucial and what are simply not that important! Many investors buy fourth-rate, “nothing-to-write-home-about” stocks that are not acting particularly well; have questionable earnings, sales growth, and return on equity; and are not the true market leaders. Others overly concentrate in highly speculative or lower-quality, risky technology securities.
6. Not having specific general market rules to tell you when a correction in the market is beginning or when a market decline is most likely over and a new uptrend is confirmed. It’s critical that you recognize market tops and major market bottoms if you want to protect your account from excessive giveback of profits and significant losses. You must also know when the storm is over and the market itself tells you to buy back and raise your market commitments. You can’t go by your personal opinions, news, or your feelings. You must have precise rules and follow them. People wrongly think you can’t time the market.
7. Not following your buy and sell rules, causing you to make an increased number of mistakes. The soundest rules you create are of no help if you don’t develop the strict discipline to make decisions and act according to your historically proven rules and game plan.
8. Concentrating your effort on what to buy and, once your buy decision is made, not understanding when or under what conditions the stock must be sold. Most investors have no rules or plan for selling stocks, meaning that they are doing only half of the homework necessary to succeed. They just buy and hope.
9. Failing to understand the importance of buying high-quality companies with good institutional sponsorship and the importance of learning how to use charts to significantly improve selection and timing.
10. Buying more shares of low-priced stocks rather than fewer shares of higher-priced stocks. Many people think it’s smarter to buy round lots of 100 or 1,000 low-priced shares. This makes them feel like they’re getting a lot more for their money. They’d be better off buying 30 or 50 shares of higher-priced, better-quality, better-performing companies. Think in terms of dollars when you invest, not the number of shares you can buy. Buy the best merchandise available, not the cheapest.
Many investors can’t resist $2, $5, or $10 stocks, but most stocks selling for $10 or less are cheap for a reason. They’ve either been deficient in the past or have something wrong with them now. Stocks are like anything else: the best quality rarely comes at the cheapest price.
That’s not all. Low-priced stocks may cost more in commissions and markups. And since they can drop 15% to 20% faster than most higher-priced issues can, they also carry greater risk. Most professionals and institutions normally won’t invest in $5 and $10 stocks, so these stocks do not have a top-notch following. Penny stocks are even worse. As discussed earlier, institutional sponsorship is one of the ingredients needed to help propel a stock higher in price.
Cheap stocks also have larger spreads in terms of the percentage difference between the bid and ask price. Compare a $5 stock that trades $5 bid, $5.25 ask with a $50 stock that trades $50 bid, $50.25 ask. On your $5 stock, that $0.25 difference is 5% of the bid price. On your $50 stock, that $0.25 difference is a negligible 0.5%. The difference is a factor of 10. As a result, with low-priced stocks, you tend to have much more ground to make up from your initial buy point just to break even and overcome the spread.
11. Buying on tips, rumors, split announcements, and other news events; stories; advisory-service recommendations; or opinions you hear from other people or from supposed market experts on TV. Many people are too willing to risk their hard-earned money on the basis of what someone else says, rather than taking the time to study, learn, and know for sure what they’re doing. As a result, they risk losing a lot of money. Most rumors and tips you hear simply aren’t true. Even if they are true, in many cases the stock concerned will ironically go down, not up as you assume.
12. Selecting second-rate stocks because of dividends or low price/earnings ratios. Dividends and P/E ratios aren’t anywhere near as important as earnings per share growth. In many cases, the more a company pays in dividends, the weaker it may be. It may have to pay high interest rates to replenish the funds it is paying out in the form of dividends. Better-performing companies typically will not pay dividends. Instead, they reinvest their capital in research and development (R&D) or other corporate improvements. Also, keep in mind that you can lose the amount of a dividend in one or two days’ fluctuation in the price of the stock. As for P/E ratios, a low P/E is probably low because the company’s past record is inferior. Most stocks sell for what they’re worth at any particular time.
13. Wanting to make a quick and easy buck. Wanting too much, too fast—without doing the necessary preparation, learning the soundest methods, or acquiring the essential skills and discipline—can be your downfall. Chances are, you’ll jump into a stock too fast and then be too slow to cut your losses when you are wrong.
14. Buying old names you’re familiar with. Just because you used to work for General Motors doesn’t necessarily make it a good stock to buy. Many of the best investments will be newer entrepreneurial names you won’t know, but, with a little research, you could discover and profit from before they become household names.
15. Not being able to recognize (and follow) good information and advice. Friends, relatives, some brokers, and advisory services can all be sources of bad advice. Only a small minority are successful enough themselves to merit your consideration. Outstanding stockbrokers or advisory services are no more plentiful than outstanding doctors, lawyers, or ballplayers. Only one out of nine baseball players who sign professional contracts ever make it to the big leagues. Most of the ballplayers coming out of college simply are not even professional caliber. Many brokerage firms have gone out of business because they couldn’t manage their own money wisely. In the 2000 era, some used unbelievable leverage. You never want to make excessive use of borrowed money. That will get you into trouble.
16. Cashing in small, easy-to-take profits while holding your losers. In other words, doing exactly the opposite of what you should be doing: cutting your losses short and giving your profits more time.
17. Worrying way too much about taxes and commissions. The name of the game is to first make a net profit. Excessive worrying about taxes usually leads to unsound investment decisions in the hope of achieving a tax shelter. You can also fritter away a good profit by holding on too long in an attempt to get a long-term capital gain. Some investors convince themselves they can’t sell because of taxes, but that’s ego trumping judgment.
The commissions associated with buying and selling stocks, especially through an online broker, are minor compared with the money to be made by making the right decisions in the first place and taking action when needed. The fact that you pay relatively low commissions and you can get out of your investment much faster are two of the biggest advantages of owning stock over owning real estate. People can get over their head in real estate and lose money when they overstep themselves. With instant liquidity in equities, you can protect yourself quickly at low cost and take advantage of highly profitable new trends as they emerge.
18. Speculating too heavily in options or futures because you see them as a way to get rich quick. Some investors also focus mainly on shorter-term, lower-priced options that involve greater volatility and risk. The limited time period works against holders of short-term options. Some people also write “naked options” (selling options on stocks they do not even own), which amounts to taking greater risk for a potentially small reward.
19. Rarely transacting “at the market,” preferring instead to put price limits on buy and sell orders. By doing so, investors are quibbling over eighths and quarters of a point (or their decimal equivalents), rather than focusing on the stock’s larger and more important movement. With limit orders, you run the risk of missing the market completely and not getting out of stocks that should be sold to avoid substantial losses.
20. Not being able to make up your mind when a decision needs to be made. Many investors don’t know whether they should buy, sell, or hold, and the uncertainty shows they have no guidelines. Most people don’t follow a proven plan, a set of strict principles or buy and sell rules, to correctly guide them.
21. Not looking at stocks objectively. Many people pick favorites and cross their fingers. Instead of relying on hope and their own opinions, successful investors pay attention to the market, which is usually right.
How many of these describe your past investment beliefs? Poor methods yield poor results; sound methods yield sound results.
Here’s some special advice just for successful intelligent men who believe they are using CAN SLIM. Stop trying to make CAN SLIM much better by adding your favorite tools, market indicators, special formulas you’ve created, other services, publications, opinions of experts on TV, your own opinion of the economy or market, past habits, value measurements, or other diversions that dilute results and create confusion at decision time. Follow the rules, kick the ego, stay on track.
After all of this, never feel discouraged. Remember what Rockne said: “Build up your weaknesses until they become your strong points.” It takes time and a little effort to get it right, but it’s worth every minute you spend on it. America offers a never-ending parade of new, growing companies. You can learn to invest with knowledge and confidence to protect your money and find and properly handle highly successful companies. You can learn how to successfully invest in stocks.