A Seven-Step Action Plan To Avoid Common Investment Mistakes
#1 - Spend some time and effort getting to know the company and its products.
When you find a company that you are considering as an investment, never hesitate to call that company directly and start seeking information. Unfortunately, investors for the most part are too trusting, and they are afraid to call a listed company's offices and start asking questions.
#2 - Check the daily trading volume of the stock you are purchasing as a general measure of the amount of buying and selling occurring for the stock.
For a small company, trading volume is a good indicator of the amount of interest in its stock. If the price of the stock suddenly moves up on low volume, there is a tight float - which means that liquidity is a problem, and getting out of the investment may be difficult for lack of buyers. Never invest in a small company that experiences spurts of heavy volume followed by days, perhaps even weeks, of light volume. The trading volume can be easily checked on a daily basis and the Wall Street Journal is still your best bet for doing that.
#3 - Find out how many market makers there are trading the stock on a frequent basis.
The more market makers there are, the better the liquidity in the stock. So never invest in any stock that has fewer than ten market makers. In a case where there are only one or two companies making a market, the market maker can artificially decide what the value of the stock should be.
For example, let's say you own 10,000 shares of stock A and you wish to sell that stock at the current market price of $5 per share. But there is only one buyer in the marketplace - the market maker - who will purchase your stock. However, when he sees that your order to sell is coming in, he will drop the price of the stock because he knows that you will have only two choices: Either you sell the stock to him, or you hold on to it.
In cases where the market maker has a buyer for your stock or is himself accumulating the stock, he will pay you the higher price. However, such cases are rare. The stock you are selling is marked by a bid price and an asked price. The bid is what a market maker is willing to pay you for a specified number of shares - but you don't know how many shares he is good for at that price. If he is only good for 500 shares at the $5 bid price, he will take the first 500 shares at that price, then lower his bid for more shares.
With more market makers bidding for the stock, you are better able to get out of your position at close to the price you are offered for your stock. In other words, there is more liquidity.
#4 - Check the spread for the issue that you are purchasing.
The spread refers to the difference between the bid price and the asked price. The spread is also the gross profit made by the trader in the transaction. In small-cap stocks, it is not uncommon to see a spread of a half-point or more. If a stock is traded at $5 bid and $5.50 asked, the spread is 50 cents. You are at a 10% plus (more with commissions) loss the minute you buy the stock, because you will be paying the asked price of $5.50, plus commissions, and, if you want to sell immediately, you will receive less than $5 net from the transactions.
#5 - Do not trust company research reports provided by brokerage firms.
These reports are nothing more than glorified sales brochures that are slanted toward selling the company. A little personal research into the company will go a long way in helping you decide if the investment is viable for you.
Treat the purchase of stock the same way you would treat having your car repaired. The local library, independent investment publications, and good judgment are your best sources for a good decision.
Collusion between companies and "pushers" of the stock, those brokerage firms who hold a large position, are also an artificial stimulus for the stock price.
#6 - Take the following steps to prevent churning.
* Set priorities that specify the type of trading in your account.
* Set profit and loss goals to be met within specific time periods. But be careful to set your profit expectations realistically.
#7 - Check the consensus before buying.
There is one source that may help you decide whether a security is overvalued or if there is a strong opinion that the company is not all the stock price makes it out to be. Check the short positions in the issue you are considering for purchase. The short list is published in the Wall Street Journal at least once a month, usually on the 15th.
If you find a company that has a short position equal to the number of shares trading in the float, this would mean that there are a lot of people who strongly believe that the company's share price was due for a fall... In the brokerage business, overvalued stocks are usually classified as "growth stocks."
* * * * *
When you find a company that you are considering as an investment, never hesitate to call that company directly and start seeking information. Unfortunately, investors for the most part are too trusting, and they are afraid to call a listed company's offices and start asking questions.
#2 - Check the daily trading volume of the stock you are purchasing as a general measure of the amount of buying and selling occurring for the stock.
For a small company, trading volume is a good indicator of the amount of interest in its stock. If the price of the stock suddenly moves up on low volume, there is a tight float - which means that liquidity is a problem, and getting out of the investment may be difficult for lack of buyers. Never invest in a small company that experiences spurts of heavy volume followed by days, perhaps even weeks, of light volume. The trading volume can be easily checked on a daily basis and the Wall Street Journal is still your best bet for doing that.
#3 - Find out how many market makers there are trading the stock on a frequent basis.
The more market makers there are, the better the liquidity in the stock. So never invest in any stock that has fewer than ten market makers. In a case where there are only one or two companies making a market, the market maker can artificially decide what the value of the stock should be.
For example, let's say you own 10,000 shares of stock A and you wish to sell that stock at the current market price of $5 per share. But there is only one buyer in the marketplace - the market maker - who will purchase your stock. However, when he sees that your order to sell is coming in, he will drop the price of the stock because he knows that you will have only two choices: Either you sell the stock to him, or you hold on to it.
In cases where the market maker has a buyer for your stock or is himself accumulating the stock, he will pay you the higher price. However, such cases are rare. The stock you are selling is marked by a bid price and an asked price. The bid is what a market maker is willing to pay you for a specified number of shares - but you don't know how many shares he is good for at that price. If he is only good for 500 shares at the $5 bid price, he will take the first 500 shares at that price, then lower his bid for more shares.
With more market makers bidding for the stock, you are better able to get out of your position at close to the price you are offered for your stock. In other words, there is more liquidity.
#4 - Check the spread for the issue that you are purchasing.
The spread refers to the difference between the bid price and the asked price. The spread is also the gross profit made by the trader in the transaction. In small-cap stocks, it is not uncommon to see a spread of a half-point or more. If a stock is traded at $5 bid and $5.50 asked, the spread is 50 cents. You are at a 10% plus (more with commissions) loss the minute you buy the stock, because you will be paying the asked price of $5.50, plus commissions, and, if you want to sell immediately, you will receive less than $5 net from the transactions.
#5 - Do not trust company research reports provided by brokerage firms.
These reports are nothing more than glorified sales brochures that are slanted toward selling the company. A little personal research into the company will go a long way in helping you decide if the investment is viable for you.
Treat the purchase of stock the same way you would treat having your car repaired. The local library, independent investment publications, and good judgment are your best sources for a good decision.
Collusion between companies and "pushers" of the stock, those brokerage firms who hold a large position, are also an artificial stimulus for the stock price.
#6 - Take the following steps to prevent churning.
* Set priorities that specify the type of trading in your account.
* Set profit and loss goals to be met within specific time periods. But be careful to set your profit expectations realistically.
#7 - Check the consensus before buying.
There is one source that may help you decide whether a security is overvalued or if there is a strong opinion that the company is not all the stock price makes it out to be. Check the short positions in the issue you are considering for purchase. The short list is published in the Wall Street Journal at least once a month, usually on the 15th.
If you find a company that has a short position equal to the number of shares trading in the float, this would mean that there are a lot of people who strongly believe that the company's share price was due for a fall... In the brokerage business, overvalued stocks are usually classified as "growth stocks."
* * * * *
posted by Bob Moser at
5:11 PM
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