Excerpted from Stock Investing For Canadians For Dummies by Andrew Dagys and Paul Mladjenovic . Want to win a copy of a book like this? Check out our free giveaway at the bottom of this excerpt.
1. Accrue Cash
Always try to have some extra cash on the sideline no matter how tempted you are to be 100 percent fully invested. You never know when buying opportunities may show up, especially in stocks you already own. Being in cash is its own form of diversification away from market risk.
2. Spread Your Money across Several Stocks
You should never have too much tied to a single stock because it's way too risky. Spread your money elsewhere. As a general rule of thumb, you shouldn't have more than 15 percent of your financial assets tied to a single company.
3. Buy More of a Down (Yet Solid) Stock
Gadzooks! Your stock just went down like a lemming off a cliff! What a rotten day in the market. Now what do you do? Well, if you've chosen well (profitable company, good industry, and so on), then why not buy more? If you bought a solid, profitable stock at $44, then why not pick some up at $33? That way you can dollar-cost average a bit and end up with a better cost basis. When the inevitable rebound in the stock price occurs, you're looking pretty smart.
4. Apply Long-Term Logic
Even if you've done your homework and chosen well, you may still find yourself scratching your head and saying, "Holy Moly! My stock just went down. What the heck happened?!" It's happened to us many times. You may make what you think is the greatest choice in stock market history and still see the price decline. What's a prudent investor to do? Believe it or not, wait. Wait? Yes . . . wait. Markets move in irrational ways in the short term, but rationality finally kicks in after a longer time horizon (such as 12, 18, or 24 months or longer).
Common sense takes over regarding a stock price over a protracted period. Long term, good choices go up and bad choices go down. Sooner or later, market participants (millions of both big and small investors) finally notice good companies and invest accordingly.
5. Use the Almighty Stop-Loss Order
Getting jittery about the market? What's happening with your stock? Keep in mind that success with your stocks isn't just based on what you invest in - it's also based on how you invest. The stop-loss order is a perennial standby, and you should reach for it as often as the police commissioner reaches for the superhero hotline.
A stop-loss order is simply a conditional order that you put in with your brokerage firm on a stock you hold in your account. If the stock is at, say, $50 per share, you can put a stop-loss order in at $45 so that if your stock falls and hits $45, it's automatically sold. Keep in mind that a stop-loss order is also a time-related order; you can stipulate that it can be a day order or a good-till-cancelled (GTC) order. The day order expires at the end of trading that day, while the GTC order expires at a much later time (determined by the broker).
6. Use the Almighty Trailing-Stop Order
The trailing-stop order is a nice variation on the stop-loss order that we discuss in the preceding section. This order takes the stop-loss order a step further by making it move upward with the stock but not budging on the down side. In other words, the stop loss trails the stock's price upward but won't adjust downward. You set the trailing stop at a percentage (or dollar amount) below the stock price.
For example, say your stock is at $50; you can set the trailing stop at 10 percent below and make it a GTC order. If the stock falls to $45 (which is 10 percent below $50), it's then automatically sold to prevent further losses. But if the stock rises to, say, $60, the trailing stop adjusts upward and would then be at $54 (10 percent below the stock's new price). Should the stock reverse and then fall, the trailing stop stays put at $54 and a sell order is then triggered. At that point you've protected 100 percent of your original investment ($50 per share) and the $4 profit, too.
7. Set Up Broker Triggers
Don't be gun-shy about broker triggers (like that pun?). These are just orders and/or e-mail alerts that brokers use to help their customers navigate the market environment. Is some news hitting your stock or its particular industry? Triggers act like an early warning system when certain events and conditions occur so that you can act on them (by buying or selling your stock). Many brokerage firms have Web sites that allow you to customize your orders. In addition, Web sites such as Globe Investor, MarketWatch and Bloomberg can e-mail you news alerts on stocks and market news.
8. Consider the Put Option
A put option is a speculative vehicle that helps you make money when you bet on an investment (such as a stock) going down. Put options are beyond the scope of this book, but that doesn't mean we can't whet your appetite about something we feel is a good alternative to simply watching your investment decrease. The type of put option we want to mention is referred to as a protective put.
Many people buy puts when they're betting (and hoping) that a particular stock will go down. Of course, if you own that particular stock, you certainly aren't hoping that it goes down, but you can get a protective put as a form of insurance in case the stock does decline. In this case you buy a put on your own stock. If the stock goes down (temporarily), your protective put goes up. You can then hold on to the stock and sell the put option at a profit. The profit you make on the put can offset (wholly or partially) the temporary decline in the stock.
9. Check Out the Covered Call Option
Writing covered call options is a good way to generate income from an existing stock in your portfolio. Simply stated, a covered call option is a vehicle that gives you a chance to make money from stocks in your brokerage account. It's an ultra safe way to generate more income - as much as 10 percent, 15 percent, or more - from your stock position.
Covered call options are beyond the scope of this book, but we recommend that you look into them, as they can be a safe wealth-building feature, even in portfolios that are temporarily down. You can find excellent tutorials and beginners' information on both covered call options and protective puts at places such as the Chicago Board Options Exchange and the Options Industry Council.
10. When All Else Fails, Sell
The most successful investors in history have taken their lumps. As the old adage goes, "Keep your winners and sell your losers." You sell losers to minimize the downside. It's easier to recoup a 10 per cent or 20 per cent loss in your portfolio on the whole than it is to recoup a huge loss in a particular stock. In addition, for what it's worth, the losses are usually tax-deductible, which can at least help minimize the pain at tax time.
Excerpted from Stock Investing For Canadians For Dummies, 3rd ed. Copyright (c) 2010 by John Wiley & Sons Canada, Ltd., with permission of the publisher.
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