Wall Street Strategies - Three Big Mistakes

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Mistake Number One: Exiting
By: Charles Payne, CEO & Principal Analyst

Without a doubt, exiting a stock is the most difficult part of the investment cycle. It is very easy to buy a stock. Ironically, this is where the exiting problem begins. Once I did an interview on television and the commentator asked me and the rest of the panel if using stop losses was a good idea. Everyone said yes, but I added a twist saying using stops should be determined based on why you're in the position in the first place. Here is where I was going.

Frustration

If you buy a stock simply because the stock was touted on TV, the Internet, or in a newspaper, then you are piggybacking on someone else's conviction. If you buy a stock because of a chart pattern, you are making assumptions based on past precedents (like a stock climbing through a double top or bouncing off a reverse head and shoulders formation) and future assumptions that have nothing to do with fundamentals. We think there is a valid place for charts, but to use them as the prime source of long term investing decisions will eventually result in anguish.

So you own XYZ Semiconductor at $43.00 a share and the broad market is lower because North Korea lobs a wobble missile into the Sea of Japan and threatens to do further testing firings, too. XYZ Semiconductor stumbles to $40.00 a share…now what? Well some people believe in using automatic stop losses. Experts often suggest these stops be anywhere from 5% to 10% of the current share price and adjusted once the stock moves higher (also known as a trailing stop).

Our theory on stops is that it should be used only if you're a trader; you buy stocks and take short term gains typically in one to thirty days. The reason we think you have to use stops with this approach is because since you are limiting your upside, you must limit your downside, too. That said, however, if you are an investor then you have to be able to weather the periodic downside moves without limiting your profits or taking unnecessary losses.

If XYZ Semiconductor recently posted its earnings results and relayed the following developments, it would not only be a hold, but probably a buy on weakness as well:

Organic top line revenue came in above company and Wall Street consensus
Spending was contained without sacrificing research and development
The effective tax rate held at the same level or was lower
The Company is taking market share from rivals
Management touts its product pipeline
The Company raises its guidance above consensus estimates

Of course if you owned this stock from a tout, then you more than likely would have sold. If you were using a trailing stop, then more than likely you would have sold. If you were listening to the doom and gloom on television, then more than likely you would have sold.

If you would have sold XYZ Semiconductor, more than likely you would live to regret it.

Real Life Case Study

Crocs (CROX)

Top line revenue growth coupled with improving margins (measured on a year to year basis) should have given a person confidence to be an investor in Crocs. Look at the operating margin trend higher over time and surge on a year to year basis each quarter.

Stopping out and missing Out on Big Money

On the way up there would have been many instances where investors employing automatic stop losses would have been shaken out of CROX. Forget 5 to 10% stops most people would have been shaken out of this stock several times on the way up if they only relied on share price to convey whether a stock was a good or bad investment. Ignoring or not knowing the fundamentals expressed in the table above would have meant a lack of confidence in the stock. Here are the periods when it was vital to believe in management's ability to execute.

On May 5, 2006, the stock hit high of $18.50 only to stumble to $10.78 by June 6, 2006 for a decline of 71.6%.
On August 4, 2006, the share price reached a high of $15.37 then proceeded to pullback to $12.36 for a decline of 24.36%.
On November 17, 2006, the share prices rallied to $25.12 then slid to $20.44 or a 22.90%.
On February 9, 2007, the shares spiked to $29.28 a share and then fell to $21.67 for a 35.12% decline.
On June 22, 2007, the stock hit $47.41 and was subsequently sacked to $40.38 by June 29 for a quick 17.38% decline.

Here are the five times when most investors would have bit the bullet simply based on the actions of the crowd.

Next Mistake: Cheap Stocks

3 Mistakes that are killing your portfolio

How WStreet Can Help
Now more than ever knowing what's under the hood matters. Get your free copy of Charles Payne's Money Show University presentation "Getting the Market Right by Shedding Horrible Habits". This is a 61 page education piece. Plus a free copy of "Shaken Not Stirred", a case study of the APPL stock's amazing fall and rise.

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To serve you better we would like to understand your investing temperament and goals. Please answer these questions and tell us a bit about your trading.

Have you sold out of the market recently solely out of fear? Yes No

Have you promised yourself to buy on weakness in the past but you just stayed on the sidelines? Yes No

Do you only use charts to make investment decisions? Yes No

Do you call yourself an investor but every time the market is tested you get so nervous you can't sleep? Yes No

Have you ever sold simply because a stock was higher only to regret it a week, month or year later? Yes No

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If you’ve answered yes to any of these questions then you need to understand fundamental investing and how it could help you handle the inevitable ups and downs of the stock market. The big guys that pull the strings know how to make individual investors sell to create opportunities for themselves and they know how to get them to buy at the top, too. We have an analytical team that sells research to institutions. We use that same brain power and know-how to assist individual investors in the creation of wealth in the stock market, too.

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