Is your head in the sand because you didn't have a plan?

Head in the sand

You've just been sold a great story by your stock broker/adviser with regards to a specific stock. Maybe you've been given a "hot tip" from someone in your office or a good pal. "Jim's dad knows a guy who works for a guy who told him about this great stock..." Or, you've actually done your own research and now you're ready to pull the trigger and buy that "sure thing". Done. You're now the proud owner of company XYZ and you're sure it's going to be a big winner. You can already imagine how sweet that cocktail will taste on that beach holiday you'll book or that new big screen TV that you'll buy with the profits. All you have to do is sit back and watch the stock go to the moon.

 

Sound familiar? It happens all the time even to experienced investors and traders. You buy the stock because you feel so good about the compelling story, the explosive chart pattern or the idea that the stock couldn't possibly go any lower. You're blind to the realities of what can happen to your "investment" because you're so emotionally involved in the idea of making money.

 

Hitting the buy button is by far the easiest part of buying a stock. It probably takes less than 30 seconds and a monkey could probably do it. Having a complete plan in place before you buy and managing the position is by far the most important aspect of any stock purchase but so few people ever do it.

 

The most familiar scenario is that there's no plan in place but you move forward and purchase the stock because the story is so compelling and you don't want to miss out on the easy money. It goes up, down and sideways from day to day but all of a sudden it starts to move lower. You open up your stock quote app on your smartphone one day and realize that your sure thing investment is now down 50%. You think to yourself, its only a paper loss I'm sure it will "bounce" back. This is what's called burying your head in the sand or "hoping" the stock will magically rally back to break even.

 

As I've said before "doubles" or 100% winners are not easy to come by. The chance of the stock you bought getting back to break even is very unlikely. The key is to not let this happen in the first place and it can be easily avoided by having a written plan.

 

Lets rewind to the beginning of this scenario and assume the decision to buy that fantastic stock has been decided. Now what? Do you just buy an arbitrary number of shares and hope for the best? The first question you need to ask is how much am I willing to lose or put at risk on this position? How much "heat" or room am I willing to allow the stock to move against me before I sell for a loss? Or more simply at what price am I going to get out? This is called a stop- loss. Once these questions are answered it will dictate the amount of shares you're capable of purchasing which will be your position size.

 

The decisions don't only exist to manage your risk if the stock moves lower. What if the stock starts to move in your favor and goes higher? What are you going to do? Are you going to take profits on part or all of the position at a certain point? Are you going to use a trailing stop? Maybe you're going to add more shares to take advantage of the current trend or you've decided to hold the stock to retirement until you need the money?

 

If you don't know the answers to these questions you really shouldn't be buying individual equities, especially stocks that are speculative or carry more risk than your average "blue chip" company.

 

The next time you buy a stock on your own or on the advice from some other source, make sure you've answered the above questions and have the discipline to follow your plan. If you don't there is a good chance you will end up burying your head in the sand.