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Better Investing
The Smart Profits Report: Issue #468
Monday, October 29, 2007
Better Investing: Steer Clear Of Embellished Earnings With A Position Sizing Strategy
By Marc Lichtenfeld
Senior Analyst, Mt. Vernon Research
There’s nothing worse for a writer than writer’s block. As time drifts away, we sit there, staring at the page, waiting for a flash of inspiration to hit. Possible solutions include: making a snack, chatting with someone, going for a run, doing laundry. Whatever it takes until the ideas start flowing and that blank page starts to get filled. Eventually, we find a way to battle through and complete the task - and feel mighty tired at the end of it!
But the same “block” theory can also apply to investing. And the better investors know that forcing the issue is more likely to result in a loss.
When the stock market is rolling, the best stocks practically yell at us to buy them - and buy them fast. But most of the time, you’ve got to dig deeper to find the gems. And even then, pouring over the financials, charts and company-related news can still leave you scratching your head.
But the key rule to better investing is this: If you don’t have any good investing ideas, don’t force the issue. Let’s see how to avoid it…
The Biggest Mistake That Rookie Investors Make
This key rule to better investing has served me well over the years. But many misguided investors find money burning a hole in their investment accounts and buy stocks for the sake of it, just so they’re “in the market.”
Don’t do it. Sure, when the market is headed higher, it’s tough to sit back and watch. And there’s nothing wrong with being “in the market” in the form of an index fund or ETF. But when you simply can’t find anything specific to invest in, sit tight. Don’t follow a “hot tip” from your friend’s dad who knows a guy who was walking down Wall Street and heard something about Company X.
Don’t just jump on the bandwagon and pile into the latest momentum stock. Be certain of the reasons that you’re putting your hard-earned money to work at someone else’s company and leaving it to the mercy of the market. If it doesn’t feel right, or is keeping you awake at night, think twice about the investment.
And right now, with earnings season in full swing, that’s more important than ever.
Don’t Fall For Embellished Earnings
Be aware that the information you act on for your investments is often massaged and embellished in the best way possible by either the company itself or by analysts before it’s released. For example, those “one-time charges” that are really recurring charges, or when a company conveniently blames the weather for its poor performance, in addition to the hype and rose-tinted outlook that some will feed the Wall Street spin machine, hoping to lure the little guy.
As you scour the financial newswires and read about the latest earnings reports, do so with a critical eye. Remember that many executives’ jobs, incentives and bonuses are based on short-term performance. They need to produce solid earnings (or at least solid projections) in order to grab that money.
You can avoid the trap with one simple approach…
Better Investing With Position Sizing
Rather than trying to time the market and cash in on unpredictable events like earnings announcements, I believe in better investing through proper position sizing.
- For example, if you’d invested $100,000 in the S&P 500 on January 1, 1995, it would have grown to $309,000 by December 31, 2006.
- However, if you’d missed the top 10 days in the market during that period, you’d only have $192,000.
- Miss the top 20 days and it becomes $133,000.
Market timing is very difficult, so make sure you invest according to your life stage and tolerance for risk.
Do not pile into any one investment at the expense of others. This exposes your portfolio to needless risk if that stock (no matter how much of a “sure thing” you think it is) happens to take a tumble. There is no such thing as a “sure thing.”
As powerful and simple as position sizing is, however, few investors actually do it. Simply put, it means investing the same amount in your investments. Got $10,000? You could put $1,000 into 10 positions. Got $30,000? Select 15 stocks and put $2,000 in each one. Invest a little to make a lot, not the other way around.
Position Sizing Eliminates Clouded Judgement & Emotions
Position sizing helps eliminate the emotion and bias that can cloud judgment. If one investment gets stung, you don’t lose the farm. Rookie investors worry about every loss and try to correct it by over-extending themselves on the next one. This is a mistake. But it’s one you can avoid if you spread your money around equally from the start.
Sure, if you’ve done your research and you like a company’s prospects, go for it. But don’t force yourself into a trade just because you have the money. Those types of trades almost never work out. Save your ammo for a clearer target. And when you do invest, don’t go nuts! Disciplined position sizing and stop-losses will give you more control, more peace - and more money through better investing.
Hoping your longs go up and your shorts go down,
Marc Lichtenfeld
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Today’s Smart Profits Action Center
- The most basic investing mistakes often have the simplest solutions. For example, many investors do all their research on a stock, then buy it… but have no idea when to get out. If you don’t have an exit plan, then any sized loss on the trade seems acceptable. Answer? Have a plan that anchors you. Ask yourself at what point you’ll sell the position, then stay disciplined and adhere to it. For example, if it’s short-term trade, make sure it stays that way. Don’t hang on longer than you want if it’s moving against you, merely hoping for a rebound. Sometimes, it’s best to cut your losses.
- Avoid the desire to be “right.” Stick to your plan and make sure that your worst-case loss on each trade is no more than 1% or 2% of your overall account.
- Find out how we apply fundamental investment principles like this to our own trading in the Xcelerated Profits Report. As 2007 comes to a close, we’ve dished some big winners this year - including 117% on a fast-growing tech company… 79% on a company leading the way in the LED industry… 65% on a defense sector heavyweight… and 45% on one of the world’s biggest oil companies. And we’ve got several other big winners in our portfolio right now. Click this link for more details.
Related Articles:
- Risk Management and Position Sizing: Three Ways To Give Your Trades A Tune-Up
- Option Position Sizing: How Much to Invest In Each Option Trade
- Price Shock: How To Respond To Three Types Of Price Shock During Earnings Season
