Ahh yes, it's that time of year again. People are taking a few days or a few weeks off for summer vacation – a time to reflect and relax. Also, based on the number of questions I'm getting on social media, a time to re-evaluate investment decisions. So let's review a few important dos and don'ts for people looking to invest their money wisely.
Some of the "rules" I'm going to discuss I learned nearly 20 years ago by studying the investment habits of the world's most famous stock trader, a man named Jess Livermore. Livermore was born in 1877 and died in 1940 having witnessed the most exciting period of American stock trading. His life is a great read in "Jesse Livermore: World's Greatest Stock Trader." In short, there are three main rules to live by that I learned by studying Livermore's habits.
The first rule is that the historical price of a stock does not dictate its future price. A stock (or any other asset) that has gone up 100 percent may very well continue to go up and similarly a stock that has gone down 99 percent may continue to go down. Don't use this metric to judge whether or not a stock is a good buy or not. Remember the last price of an asset is the last price at which two parties agreed on its value. Rational investors may differ in their assessment of the value of a stock, that's okay. The investor that sold the stock when it was down 98.99 percent to further push the price down gave up hope on that stock and had a reason for doing so. In short, stocks can continue to increase or decrease even after investors believe that "run" is over.
The second rule, which Livermore is most famous for, is his use of "probe" trades. Livermore said that before investing in an asset, set aside the total amount you're willing to invest. Next, split it up into quarters and invest the first quarter immediately. If you profit and the asset increases in value, purchase another quarter. If that increases, continue to add to your position. If the asset decreases in value, stop investing. Never "average down" or buy on "dips" in hopes that the asset will turn and you will have bought at the bottom of the market. This way you'll only lose money on a quarter of the total amount you had planned on investing.
The final rule that I find most helpful when deciding on when to sell is to ask yourself a question. Would you add to your position today? If the answer is "no, I wouldn't buy more of this asset now," then sell. Unless you are worried about lack of diversification in your portfolio if you wouldn't buy more of that asset today (if you had free cash) then sell it because you no longer believe it to be an attractive investment. If you no longer believe it to be attractive, neither will other investors and the price will go down. Better to sell before everyone else does.
If these tips are followed investment decisions will be easier to make. Happy investing!