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Investment Rule #1 - Emotion Kills

Jul 30, 2008
Entering into the stock market can be a daunting and frightening experience for the new investor. At the beginning you know next to nothing about the market, sure you can read all the books and articles you want, but you don't really know hot it feels to invest. It's one thing to understand the principles behind successful investing, it is something entirely different when your money is actually on the line. So for this article I am going to focus on the biggest mistake that new and often times seasoned investors make - emotional investing.

Whenever you buy a stock, you are hoping to make a profit on it. If that investment happens to go down, a little voice in the back of your head will say something like "this is just temporary, it will come back." Sure it might go back up, but there's also a good chance it will go down further. And when that happens the voice says "Well, maybe I should sell it, but I'll just wait for an upswing to get some of my loss back." And then the stock goes down again. And every time it goes down you will find it harder and harder to sell it off. Every time you will be hoping that you can get back just a little bit of your loss, after all how far can a stock really fall? The answer is really really really far.

Remember Lucent Technologies? A good friend of mine invested into them when their stock was around $70 per share, and then it started to tumble. Of course he was sure it would rebound, but it just kept falling, then he was sure he could just hold onto it and sell it on an upswing to get back some of his loss; he stubbornly held onto the stock till it hit $18 per share. If he decided to hold onto it just a little bit longer it would have taken him all the way down to the single digits.

This is an all too common story. Stocks go up and down all day long, so a lot of people think that if they just hold onto it a little bit longer they will be able to sell it on an upswing. The problem is that if a stock is really on a downturn, it can go down fast without ever jumping up. It is better to take a small loss, than let your whole ship sink.

On the other side of this emotional investing equation is the greed associated with a rising stock. When should you sell? You buy a stock you like, it goes up and you turn a nice profit. It goes up a little more and your profit just got bigger. In the back of your head you're thinking " if I sell now I could miss out on some really big profits! This could be the million dollar stock!" The problem of course is that most stocks will fluctuate, that upswing is most likely temporary and at some point investors will be pulling out to take a profit. If you hold onto it for too long because you're afraid of getting out too soon, you stand to lose any profits you would have made. The reality is that there is no such thing as getting out to soon. A profit is a profit. Don't let greed rule you, it is the quickest way to lose BIG in the stock market.

So how do you combat emotional investing? Pretty simple really, just set rules and always follow them. For instance if you set yourself a 10% profit rule. ALWAYS sell when your stock hits a 10% profit. On the other side set a loss rule as well, for instance decide for yourself to always sell off if your stock posts a 7% loss. Following these rules will protect you from letting your emotions; fear, greed, uncertainty, etc, from getting in the way of sound investing practices.

To simplify things, put in a sell order at the profit point you want to make (in my example about 10%) and a stop loss order at the protection point you want to sell at (7% in my example above). Whatever you do remember these simple words: Emotion is the enemy of a good investor.
About the Author
Joshua Niemeyer is the publisher of IncentiveSearch.com, he gives tips and advice on a wide variety of topics including: stocks, real estate, business development, web development, marketing, advertising and more.
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