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.
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.
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.
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.-
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 proQfits 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.
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.
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.