Paul Goodwin Advices on How to Stop Being a Stock Chump

February 1, 2013
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In this week's Stock Market Video, I look at the recent strength of the market, showing how valuable positive momentum is. The market’s sideways trading during the week is actually a good sign; pullbacks and consolidations offer good entry points and keep markets from overheating. I also looked at the positive reinforcement you can get from finding two stocks in the same industry that are doing well. Stocks discussed include two employment-related names, Robert Half (RHI) and On Assignment (ASGN), two investment bankers, Goldman Sachs (GS) and Morgan Stanley (MS), two gambling stocks, Melco

Crown (MPEL) and Las Vegas Sands (LVS) and two refiners, Valero Energy (VLO) and Phillips 66 (PSX). Click here to watch the video!

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How to Stop Being a Stock Chump

First, let me say that I don’t think you, the person reading this commentary, are a stock chump. This is addressed to all those other investors who act like chumps. But not you. You’re fine. Really.

But you have to admit, there are a lot of chumps out there. They’re the people who stand on the sidelines while a market rally is going on and get more and more excited and finally just can’t stand it any more and throw their money into the hottest of the hot stocks … which is the signal for the rally to be over. The leaders correct sharply and the professionals quickly hop off, landing lightly on their feet with their profits in their pockets, while the chumps watch in uncomprehending horror as their stocks drop like Wile E. Coyote into the canyon of steep losses.

But it doesn’t stop there. Sustained by hope, chumps hold on to those losing stocks while they continue to decline, working their way toward a messy and protracted bottom. Then, fueled by denial, they hold on, reasoning that a stock that once sold for X certainly must be worth more than 1/2 X or even 1/3 X.

And finally, after all hope has been crushed and a dull resignation takes hold, the chumps sullenly unload their losers … which is the signal for those stocks to begin rising again!

This may sound like a load of cheap irony, like the people who delight in telling us that the grocery line they choose (after a diligent search for the shortest queue) is the one that will be hit by a change of checkers, a need for a new roll of paper for the register and a call of “Price check on register three!” This is a common feeling, although rarely accurate.

But the phenomenon of chumps buying near a stock’s (or a market’s) top and selling at the bottom is very real.

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When you think about it, a stock tops out only when it reaches a price so high that the sellers outnumber the buyers. Value-oriented professionals think it’s overvalued. Technical analysts see a climax top or a decline in buying volume. The final push for a stock comes because it has momentum and the chumps finally want in.

That doesn’t mean that, by definition, the last people to buy a stock after a long rally are chumps. Aggressive growth investors will often buy stocks at what turn out to be their highs. What makes investors chumps is that they 1) refuse to cut their losses short, or 2) make the same mistake over and over, or 3) conclude that the stock market is a fool’s game and never invest again. As we like to say, in investing it’s okay to be wrong, but it’s a sin to stay wrong.

But this piece is called “How to Stop Being a Stock Chump.” And since it doesn’t apply to you, you’ll want to be thinking about someone to whom you’d like to send it.

A person stops being a chump by finding a successful investing system that makes sense to them and then following it! It’s that simple. And if you’re wondering what an investing system looks like, you should go back to Mike Cintolo’s Cabot Wealth Advisory from yesterday (January 31), which is about as good a free introduction to finding a system as I’ve ever read. It also gives you a little insight into the mind of someone who genuinely loves analyzing football. Here’s a link.

Having a system is vital because it gives you a framework for finding, buying and selling stocks. Without a system, a potential investor gets stock ideas from anywhere and everywhere. Ideas come from familiar names, news stories, television (including the entertaining cult guru Cramer and the systemic overload of CNBC), friends and relatives, or, worst of all, from e-mail or snail-mail stock touts.

Without a system, you might get one idea from a portfolio manager on television who describes a company as having excellent growth prospects and a reasonable valuation, then another from Cramer, then a final one from your brother-in-law. Congratulations, you now have one lumbering blue chip that won’t go anywhere for years, one high-flying tech stock that will streak to a climax top in a week and a pink-slip pharmaceutical stock that will jump around like a monkey on speed.

What this gives you isn’t a portfolio … it’s the dog’s dinner. These stocks have no theme, no common style, nothing that will let you compare them in a meaningful way so you can manage them responsibly. And because the portfolio has no style, the investor has no rules or tools to give advice on when to sell. You can make money as a value investor. You can also make money using the growth style or a sector strategy or as a swing trader. But you probably can’t do all of them successfully at the same time.

Personally, growth investing is a great style for me because it’s interesting. You can dial your risk level up or down until you find a level of aggressiveness that keeps you interested but still lets you sleep at night. And there are newsletters (like many of Cabot’s) that will supply stock ideas, tips on market timing and trends, and commentary that will let you develop your style and hone your skills. In other words, they can help that friend of yours (or even you) to stop being a chump.

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Those-Who-Buy-at-Tops-often-sell-at-bottomsHere's this week's Contrary Opinion Button. Remember, you can always view all of the buttons by clicking here.

Those Who Buy at Tops Often Sell at Bottoms 

Tim’s Comment: Those who buy at tops, of course, have the biggest losses at bottoms, and thus they are most likely to capitulate. More broadly, those investors who are most susceptible to public opinion will be the last to buy (creating a top) and they will also be the last to sell, creating bottoms.

Paul’s Comment: The people who finally conquer their fear and jump into the market at the top and those who stubbornly hang on until the end of the bottom are usually driven by emotion. The market loves them, because they’re the ones who supply the profits at the end of bull markets and the bargains at the end of bears. Bless them. But don’t be one.

In case you didn't get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, there are links below to each issue.

Cabot Wealth Advisory 1/28/13—Apple: Final Thoughts

Tim Lutts, Cabot’s Chief Investment Strategist, looks at how one Cabot publication can love Apple (AAPL) while another doesn’t. The difference is the difference between growth and value stocks. Tim also gives the sixth of his “Ten Stocks to Hold Forever,” this time featuring LinkedIn (LNKD).

Cabot Wealth Advisory 1/29/13—Another Perspective on Apple

Cabot Option Trader expert Rick Lehman used this issue to look at Apple (AAPL) from a fundamental point of view, concluding that the stock was actually quite cheap from a fundamental point of view, especially versus Netflix (NFLX) or Amazon (AMZN).

Cabot Wealth Advisory 1/31/13 — Finding the Investment System that Works for You

Mike Cintolo, editor of Cabot Market Letter, looks at football as a model for finding the best investing system. He concludes that the best system is the one that is best suited to your own strengths. Stock discussed: Urban Outfitters (URBN).

Have a great weekend,

Paul Goodwin

Editor of Cabot Wealth Advisory
and Cabot China & Emerging Markets Report

Related Articles:

20 Tips to Become a Better Investor

How to Know When the Bull Takes Charge

Why Invest in Stocks?
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