As I mentioned last week, I recently collected the responses
from the survey found at the bottom of each issue of Cabot Wealth
Advisory. Many of you have taken the time to fill it out and I
appreciate all of your feedback.
The same questions came up again and again, so for the next few
weeks, I'll be going over those topics. Today, I'm going to
discuss something that came up frequently: beginning investing.
Many of our readers are already experienced investors, but a lot
of you are completely new to the game. So today I'm going to
attempt to get the new folks up to speed in the hopes that having
more basic knowledge will give you the tools you need to better
understand what we write about. (Note: These lessons primarily
apply to growth investors, but they can be beneficial to
everyone's investing strategy.)
Why should you own stocks?
Over the long term, stocks have outperformed all other
investments. From 1926 to 2008, S&P 500 stocks brought
investors an average annual return rate of 9.6%. Stock ownership
entitles you to benefit from price increases and to receive
dividends the company distributes.
How many stocks should you own?
We generally recommend owning no more than 12 stocks. That allows
winners to truly have a big positive effect on your portfolio,
while at the same time preventing losers from sinking it
completely. We advise investing equal dollar amounts in each
stock to balance risk.
How does Cabot pick growth stocks?
Cabot's growth stock selection system starts by focusing on
stocks that are strong and going up faster than the general
market. These stocks are said to have positive momentum. But we
need to see more than that. Behind each stock, we want to see a
great growth company. In most cases, we require a company to be
demonstrating strong growth of both sales and earnings. And we
want to find a story that convinces us this great earnings growth
is likely to continue in the years ahead. This system is followed
in Cabot Market Letter, Cabot Top Ten Weekly, Cabot Green
Investor and Cabot China & Emerging Markets Report.
What is relative performance?
Relative performance (
) is a measurement of how a stock is acting relative to the
market as a whole. It is one of the tools used by Cabot growth
stock analysts to gauge a stock's momentum. When a stock's RP
line is moving upward, the stock is performing better than the
general market; when the RP line is moving downward, the stock is
performing worse than the market; and when the line is level, the
stock is performing the same as the market.
What is market timing?
We are strong believers in long-term market timing, mainly so we
can sell stocks and raise cash to avoid losing money when the
broad market enters into a major decline. Market timing is not an
exact science, but we've had great success timing the market over
the years so we feel confident in recommending that all growth
investors practice it. Our three primary market timing indicators
are Cabot Trend Lines, Cabot Tides and the Cabot Two-Second
The Cabot Market Letter averages one major market-timing signal
per year. If it's a sell signal, we work to reduce risk by
selling our poorest performing stocks and putting close limits on
the others. The object is to reduce the risk of loss and to raise
cash for the next buy signal, when bargains abound. When that buy
signal comes, we invest aggressively in the best-performing
stocks we can find. Interestingly, that's the time investors are
How do I know when to sell a growth stock?
The most important rule in growth investing-and the hardest to
learn is, "Cut your losses short." That means if your loss in a
growth stock exceeds 15% (in a bear market) or 20% (in a bull
market) at the end of any trading day, you sell. Period. In
general, we also believe it is wise to sell a stock when it has
underperformed the market for eight weeks. The stock's RP
(relative performance) line is a good indicator of this.
On the other hand, you will have many winners, and knowing when
to sell them is more difficult. These are stocks in which you
already have doubled your money--or more, and still see the
potential for great appreciation in the future. In such cases,
you should hang on to your stock through corrections, confident
that the long-term results will prove rewarding. If you can do
this, you'll benefit mightily from the magic of compounding.
Is it risky to buy stocks hitting new highs?
In the long run, no, because a trend, once established, tends to
persist. So if a stock's trend is up and you're convinced the
company is capable of great earnings growth in the years ahead,
you should buy. But better yet is waiting for a normal
correction, and buying a stock when it touches its 25-day moving
What are options?
An option gives you the right to buy or sell shares of a stock if
it reaches a specified price by a set date. This summer, Cabot
introduced a new publication, Cabot Options Trader, for investors
eager to trade options. Editor Rick Pendergraft is scheduled to
write an issue of Cabot Wealth Advisory later in the month, so
stay turned to learn more about options.
Which Cabot newsletter is right for me?
In addition to Cabot Wealth Advisory, which is free, Cabot
publishes 10 other newsletters covering a variety of investing
strategies. We understand that it can be difficult to decide
which one best suits your investing needs, so we created a quick
You can take it here.
That's all for today. I hope you learned something that will help
you become a more successful investor. Again, thanks to everyone
who filled out the survey ... expect to see more topics pulled
from the results in the future!
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Until next time,
Editor of Cabot Wealth Advisory