1. Never invest in the market more money than you can afford to lose. Okay, so this is more a rule than a tip, but it’s probably the most important point to make about investing in stocks.
While you can make a lot of money investing in stocks, you can also lose big, though the chances of you losing big decrease the longer you stay invested in the market and the less frequently you trade.
If you are highly risk-averse, then it’s better to totally avoid the stock market. Stick to cash or money market instruments like certificate of deposits (CDs) and commercial paper.
2. Never invest in a stock unless you understand how the company makes money. If you’re going to hold a stock for a very long time, it pays to understand how the company makes money. This will help you make better buy and sell decisions – see tip 4.
To understand how a company makes money, you’ll probably have to read its Annual Report or 10-K. Another good way to get this insight is to listen in on a company’s earnings conference call, where stock analysts grill company executives about the strategy and financial health of a company.
3. Practice Dollar Cost Averaging (DCA) when building position in a stock. DCA is an investing strategy whereby you invest the same amount of money in a stock at regular intervals – like every week or month – regardless of the price of the stock when you buy it.
If you buy when the stock is trading high, you get fewer of the stock, and if you buy when the stock is trading low, you get more of it. Many online stock broking companies will automate this process for you.
DCA allows you to build a position in a stock at a pace or contribution level you are comfortable with. Furthermore, with DCA, you don’t have to “time” the market - to try to buy at a particular price.
Until you know what you’re doing, DCA is more reasonable than buying on “gut” feeling or buying because Jim Cramer said something good about the stock on Mad Money.
4. Buy on the rumors and sell on the news. This is a common adage among investors. Once you’ve built position in a stock to a level you’re satisfied with you may want to buy and sell some of it once in a while.
Studies have shown that when the market anticipates good news from a company - like a good earnings report - its stock price often starts to rise days before the news becomes official.
Therefore, you want to buy the stock once the rumor breaks. If you buy on the day the company delivers the good news, you’d probably miss out on much of the gains.
Traders, who typically don’t hold stocks for a long time, will often sell and take “profit” once the company breaks the good news. This is what investors mean by “sell on the news”.
If the market expects bad news, then don’t wait until the company breaks the news before you sell because by that time, the stock may have bled profusely.
Now, realize that your stock does not have to be the news-maker before you act. If you hold company A’s stock and Company B, a competitor, is the news-maker, then your stock is likely to react to company B’s news since they are in the same industry.
5. To get the best prices make your trades at the start or at the end of the trading day. The first and last 20 minutes or so of the trading day often witness the most activity by investors.
During the start of trading, investors try to capitalize on news before the opening bell, so the scramble to get in or out of a stock tends to make stocks “gap up” (price shoots higher than previous day’s high) or “gap down” (price shoots lower than previous day’s low) depending on the nature of the news.
Institutional investors often come into the market to trade during the quiet times - like lunchtime - or towards the end of the trading day.
The Learning Never Stops
Continue to arm yourself with knowledge and recognize that a "trader" is different from an "investor". A trader hits and runs while an investor buys and holds.
These days, however, most self-directed investors are not on the extremes. Sometimes they run like traders, and other times they walk like investors. Get in where you fit in.
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