Want Better Returns? Start 'Dating' Your Stocks Before Falling in Love

First Date

Selecting great stocks is the first step to producing superior returns. When done right, it makes your life as a trader much easier, yet there are a number of common mistakes that can be easily avoided with a little effort.

The 'First Date' Strategy

The most important concept to embrace is that your first buy isn’t a commitment to a long-term relationship. Think of it as dating. When you first do a little checking, the situation may look attractive, but you won’t really know for sure until you spend time getting to know each other. Over time, you will learn the personality of a stock — its quirks, its weaknesses, and its strengths.

You shouldn't jump in with both feet the moment you meet, no matter how attractive the setup looks. Eventually, you will decide how serious you want to be, and that is when you increase your commitment.

Think of your initial buy as a blind date. If it doesn’t feel right, move on. You should expect plenty of failed dates before you find one that offers true long-term value.

Testing the Waters

I buy stocks every day that I don’t know much about. Sometimes they just have a good chart or an interesting piece of news. I’ll buy a small position and then try to get to know them better.

If the price action is good and my fundamental research is promising, I’ll look for opportunities to add to the position. If not, I dump it and move on.

I have hundreds of failed buys of this sort every single year. I’m not worried about hurting their feelings when I dump them.

The Trap of Averaging Down

A second issue to contemplate is the old market saying, "Losers Average Losers." This phrase was made famous by Paul Tudor Jones, who kept those words on a handwritten sign on his wall during the 1987 market crash.

The core philosophy is that winners cut their losses quickly and move on. Losers become emotionally attached to a position and try to prove the market wrong by buying more as the price drops, hoping for a bounce that may never come.

The lesson here is to ensure you are adding to a position for the right reasons. Buying a stock at a lower price than your previous entry isn't necessarily a mistake if it was part of your original plan and there hasn’t been a drastic change in technical or fundamental conditions.

However, the biggest losses most traders experience occur when they keep adding to a losing position and finally capitulate only when they can no longer stand the pain. Every experienced trader has stories about the sizable losses they suffered because they "averaged a loser" they loved.

Managing the Relationship

The most important thing to understand about buying is that it is part of an ongoing relationship. One of my primary goals when I establish a position is to always be in a place where I can buy more. To do that, I have to cut back when I have the opportunity, so I don't end up owning too much.

I will constantly take partial profits or cut on technical weakness so I have the "dry powder" to buy more when conditions improve. If the stock is too much of a disappointment, I bid it adieu and move on.

Don't Fall in Love

The best advice I can give a new investor is to enter a relationship with a stock gradually and increase intensity only as you get to know it.

Don’t fall in love on the first date. It will drive you to make poor decisions, and loving losers will eventually make you a loser.

At the time of publication, Rev Shark had no positions in any securities mentioned.