Make More Money in the Stock Market - 7 Steps to Simple Stock Investing


A lot of people who invest in the stock market would like to understand it better. Others are hesitant to jump in because it seems like a complex netherworld where anything can happen - and not always good things! Of course, one of the simplest ways to invest is to put your money in a mutual fund or ETF, and just walk away. That approach can work, and it's the approach endorsed by many a personal finance blogger. But what if you want to allocate a certain portion of your portfolio to individual stocks? Or you just enjoy playing the market with cash you've set aside for that purpose?

If that sounds like you, there are some steps that can make the process simpler and more likely to result in gains. These steps will also ensure that losses are kept to a bare minimum, one of the keys to successfully investing in individual stocks. Ideally, I'd like you use as many of these rules as possible. But even if you pick and choose, it will help you be a more informed investor. I've trained thousands of people who use these rules all the time. These are a great way to manage a portfolio of stocks.

1) Keep your portfolio size small. For each stock you own, you need at least a passing familiarity with key events that might affect its price. And it's crucial to know when the company will report quarterly results, since that can have a huge price impact, either up or down. How many stocks is the right number? Somewhere between two and ten. Broad diversification is a hedge - but funds provide hedges, so you won't need to do that in your stock portfolio. The goal here should be to have a couple of big winners, and some with smaller gains. For most people, it's best to keep the number of stocks in the 5-7 range. If you have less than $3,000 to invest in stocks, you might want to limit it to three names.

It's easy to see how crucial this rule is. A friend of mine owns about 100 different stocks in his portfolio. He routinely gets surprised by earnings reports and because there are so many stocks in there, he can't regularly track which ones are tanking and should be sold. He's lost a lot of money unnecessarily by spreading his investments too thin. Don't make that mistake.

2) Sell! People don't like selling stocks. But they're not precious heirlooms, things to be treasured for life and given a place of honor in your family. If you've made money in a stock and it's heading downhill faster than Bode Miller, then by all means, sell and keep your gains! If there's anything the 2008 and 2009 bear market has shown us, no one knows how low a stock's price might fall, or how long it might take to bounce back. Also sell immediately if your stock begins to drop too far below the point where you bought it. Definitely don't let it fall more than 10%. You might even want to sell sooner, if the price begins tanking below your original buy point.

Here's a mistake one of my cousins made: Back in April, 2008 she purchased a stock called Bois D'Arc. It's since been acquired by Stone Energy Group (SGY). When she bought, the stock was trading at around $56. It initially rose to $73, so she was doing well, making about 31%. But it started falling from its highs. And it kept falling. But my cousin wasn't watching. She moved to another state, then got busy with all those other life issues that happen, and forgot about her stock. Oops! When she finally got around to checking her brokerage account, it was March, 2009. The bear market had reached its low. Her stock had fallen 96%, to $2.50. She lost almost all of her investment, by neglecting to sell months earlier. As of this writing, it's trading around $17 - nowhere near her buy price of $56.

3) Only buy in markets trending higher: Be extremely cautious about buying when the market is trending lower. The idea of bargain hunting is ingrained in our psyche - and I, too, am in favor of finding the lowest price where it makes sense to enter a stock. But if the major indexes are heading south, avoid the temptation to shop for undervalued "gems." There's plenty of independent research to show that the majority of stocks follow the market's trend, so it's generally safer to just wait until a new market uptrend has been confirmed. There's no sense in buying a stock and watching it continue to decline along with the indexes.

You're probably wondering, how do you know for sure what the trend is, without relying on someone's hunch? There are many sites and services that tell you whether price and volume action has sent the market back into a confirmed rally.

4) What's the story? What's new and different, that's putting this company on the map? Is it offering a new service or product that's in demand from consumers or business customers? Sure, tried-and-true companies can plod along, with their price not doing much. But if you want to grab something with a better chance of big gains, look for companies that are changing their industries somehow, or are well-positioned to take advantage of new trends.

Apple (AAPL) has continually innovated for the past six years or so - and its stock has trended higher. Netflix (NFLX) had been in the toilet in the 2008 bear market, but two new developments boosted its revenue: First, a recession, which spurred consumers to seek cheaper forms of entertainment. Simultaneously, it kept improving its streaming video service, which people increasingly demanded. The stock had a quick 50% run-up between January and April of 2009, and seems that it may be poised for more gains.

5) Check the sales and earnings: Make sure the company's fundamentals have been growing, or, at the very least, has forecasts for increasing sales and earnings. When a company has a new service or product that's in demand, revenue grows. That sends profits higher. And when profits are up, more investors jump in, and that sends the price higher.

And those companies I just mentioned, with the "new" factor? Those are typically the stocks with explosive earnings and sales growth. Check out the last three quarters of earnings growth for Aruba Networks (ARUN), which went public in 2007: Triple-digit profit growth for five quarters in a row. Compare that to Microsoft. Earnings declined for four of the past five quarters. Not to pick on Microsoft, but older companies usually can't drum up the same level of growth as the best newer companies. And price growth in those more recent IPOs tends to match the fundamental growth. Where can you find fundamental data? Start with Yahoo Finance or Google Finance. Both have a stock screening tool that lets you find companies with the best sales and earnings growth. Begin by screening for quarterly and yearly increases of at least 20%.

6) A stock CAN be too thin! Yeah, they're not like most of us, in that sense.

Don't load up your portfolio with too many thinly traded stocks. Something that trades fewer than 400,000 shares per day is usually more prone to volatility. To illustrate that, let's examine a name that's performed well since its 2008 IPO, China Biotics (CHBT). It trades about 196,000 shares per day, and tends to have wide price swings from week-to-week, and also within many weeks. Thinner stocks are often prone to that kind of loose trade, which can be risky. With few shares traded, that means one or two big investors can suddenly dump shares and send the price sharply lower.

That's much less likely to happen with a stock that trades 1 million shares or more, because it takes a lot more selling to deliver a big percentage drop in price. Institutional investors generally can't go out and unload hundreds of thousands of shares all at once. So widely held stocks tend to move more slowly. That mitigates your downside risk, but it also limits your upside potential. So despite the big gains you can see in thinner stocks, it's necessary to use some extra caution with those.

7) Diversify the right way: In this case, I'm not talking about allocating different amounts to stocks, bonds or options. I'm talking specifically about your portfolio of individual stocks. Be very careful about owning too many companies whose businesses are similar.

If the sector gets hit by bad news, that could pull too many of your stocks down. Or if one stock in the group has a bad earnings report, fear could spread, hitting similar companies. So as much as you love ice cream, don't own four different ice cream companies! Same goes for oil and gas transporters, computer makers, Chinese online game companies - you get the idea. So those are some pretty simple steps toward enhancing your stock investing results, largely by making it less prone to downside risk.

Bob O'Hara is an experienced investor and stock market instructor. He's been teaching and writing about investing for more than 15 years, and has developed successful methods for buying and selling at the right times. For more details about the simple investing steps discussed here, visit his site, [].

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