The Hardest Rule For Investors To Follow

I've seen it happen to investors before. I've even been a victim of it myself. Especially in times like these. I'm talking about getting too cute when the good times are rolling...

You see, when things are going great -- in any aspect of life, but most notably in investing -- it's easy to ignore the fundamentals. The very things that got us here. We begin to take bigger risks, start investing in things outside of our wheelhouse (think bitcoin) and simply forget the basics of what it takes to succeed.

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And when the day of reckoning arrives, we freeze, we panic and we tend to forget everything we've learned about investing. We forget the basics.

Don't fall victim to this. Instead of panicking when the bad times come (because they will), you need to keep it simple. Keep your emotions in check, and remember the basic tenets of successful investing (which I'll cover in a moment).

Getting a firm grasp on these ideas now will give you a greater chance of doing the right thing when times do get tough... and possibly save you not only hundreds of thousands of dollars, but restless nights of sleep. After all, we all know to call 911 in an emergency or to "stop, drop and roll" if we're on fire, but we also need to know what to do when all hell is breaking loose in the market.

I talked about the three basic tenets of successful investing in this article. I strongly urge you to go back and read that piece in detail. But I think it's worth repeating what I shared then, because I want to dive deeper into the first guideline. That's because I believe it's one of the hardest for investors to execute and understand...

3 Tenets Of A Successful Investor

1) Have an exit strategy in place.

2) Understand and use position sizes.

3) Keep your emotions out of the market.

Rule No. 1: The Most Useful, But Hardest To Follow

"Losing money is the least of my troubles. A loss never troubles me after I take it. I forget it overnight. But being wrong -- not taking the loss -- that is what does the damage to the pocket book and to the soul." -- Jesse Livermore , Reminiscences of a Stock Operator

If you've been investing for a while, it's no secret that one of the hardest things to figure out is the right time to sell. This is especially true for a losing position. A stock goes down and we tell ourselves that as soon as it gets back to even we will sell... only to see the stock sink lower. Then we tell ourselves that we are "buy and hold" investors in it for the long haul. As the stock continues to sink we wonder how much lower can it really go. We can't sell because selling admits failure and we're hard-wired to not accept failure.

Meanwhile, this one stock becomes a major black eye in your portfolio, bringing discouragement and frustration. It really comes down to swallowing your pride, setting your ego to the side and cutting your loss.

Most investors will begin to ignore that loser and pretty soon one, two, three years pass by and the stock is still sitting at a 20%, 30%, 50% or worse loss.

But I'm going to let you in on a little secret... having an exit plan in place, and executing it, can be more satisfying than booking a solid winner.

Consider one of our former holdings, Qualcomm (Nasdaq: QCOM ). This stock provides an excellent learning opportunity. It was added to the portfolio in December 2014. For the next two years the stock languished. Not only that, but it greatly lagged its peers.

I finally cut it from the portfolio in February, over two years later. We booked a modest loss of 18.6%.

To put it simply, despite posting more than our fair share of winners in Top Stock Advisor , this is not one of them. We got this one wrong.

Fortunately, as in life, you can learn more from your mistakes than from your wins. It obviously would have been better to cut QCOM from the portfolio earlier instead of holding onto it "hoping" for a rebound. Hope isn't a strategy. But it can decimate a portfolio.

Sure, nobody likes to book a loser, but I'd much rather cut a loser short -- and invest in another opportunity -- than quietly watch my investment shrink.

Remember, in order to recover from a 50% loss we need to book a 100% winner just to break even . And triple-digit winners aren't exactly easy to come by in a short period.

This is why it's important to have some sort of stop-loss, trailing-stop, or "uncle" point when it comes to investing.

Again, figure out the most you are willing to lose on a stock before you even enter the trade. This will help you satisfy rule number one from above -- have an exit strategy in place.

At Top Stock Advisor , I loosely follow a 20%-25% trailing stop loss. I say loosely because sometimes I believe that selloffs are simply overreactions from Wall Street and represent good buying opportunities.

It's not easy to know when it's time to pull the plug on an investment. But if you implement an exit strategy for each of your holdings (and stick to it), you'll already be one step ahead of the average investor (and you'll sleep better). You'll be much better prepared for when the good times come to an end. You won't be panicking along with the majority of investors because you will have a plan in place.

I highly recommend a trailing-stop loss. A trailing-stop loss is a fixed price below the stock's highest close. As the share price rises, so does the stop-loss (hence the name trailing-stop loss).

A 20% trailing stop-loss using Intel (Nasdaq: INTC ) as an example would look like this: On October 20, shares of Intel closed at $40.43, a new high. That would put your trailing-stop loss at $32.34 a share. If shares were to close below $32.34, you sell the next day. (Please note that I use the closing price as the indicator, not an intraday price).

But shares continued to climb. On October 27, shares closed at $44.40 a share, making your new trailing-stop price climb to $35.52 a share ($44.40 x 20% = $8.88; $44.40 - $8.88 = $35.52).

The bottom line is this...

If you want to make money investing -- and not get caught unprepared -- then don't forget the basics. Be sure to have an exit plan in place.

P.S. By planning an exit strategy, you're already taking a step towards eliminating the single biggest danger facing your portfolio -- your own emotions. But in order to get rid of them entirely, and reap the benefits of smart investing, you're going to need a bit of help.

My Maximum Profit system has been helping my readers jump in and out of the market with perfect timing for years. It's simple, numerical readout tells us exactly when to buy a stock and when to get rid of it. It can even sniff out crooks like Enron and AIG -- before they cost you money.

Click here to see how the Maximum Profit system can earn you $3,200 by next month .

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

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