How To Invest: Sticking To Rules Is True Challenge
Philosopher Jacques Maritain once observed that the shortcoming of modern times is “the primacy of verification over truth.”
Many people determine what is true, and then forget about it, rather than let it nourish their lives, Maritain said.
So it is with investing.
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The hardest challenge of investing isn’t learning all the probability-based rules discussed in “How to Make Money in Stocks.”
With time and effort, you can learn the rules. The big challenge comes after you learn the rules.
The challenge? You must follow the rules!
It’s human nature to look for loopholes, exceptions, excuses — any reason to ignore a rule. But that’s the road to investor hell — a portfolio filled with “exceptions” that turn out to be exceptionally efficient at losing your money.
One rule some investors have trouble following is the rule against buying extended stocks.
A fundamentally strong stock that breaks out of a base in big volume shouldn’t be bought after it rises 5% past the ideal buy point.
Eventually an investor will encounter a situation where this rule seems like a real party pooper.
You miss the breakout and then watch the stock rise day after day.
“Surely, IBD doesn’t believe I should follow this rule all the time,” you say. (We do, except for certain gap-ups that skip the 5% range.)
There’s a simple reality that makes violating this rule risky. Most winners will rise 20%-25% and then begin consolidating. That’s why investors should take most profits at 20%-25%.
If an investor buys a stock that is extended 10%, 15% or 20% past the buy point, the investor often will be buying just in time for a downturn.
And remember, not all breakouts make it to 20%. So you might be buying extended shares from the investor who bought properly and is now cashing in. Does that sound like a winning strategy?
Southwestern Energy (SWN) broke out of a double-bottom base on Feb. 1, 2005 with a 53.19 buy point 1 . Seven sessions later, the oil and gas developer closed at 57.71, up 8% and extended 2.
After a 19% gain, the stock began to form a base on base 3. Investors who bought at the peak faced the 8% sell rule two days later 4. Those who bought only 10% extended saw a fleeting 8% gain and faced the sell rule four weeks later.
source form: investors
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