Back to Investing Basics

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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 ( RP ) 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 Indicator.

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 most fearful!

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 average.

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 quiz. 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,

Elyse Andrews
Editor of Cabot Wealth Advisory



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: COH , DIS , DRP , LINE , RP

Cabot Heritage Corporation

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