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Stock Tips: Exercising Caution

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Stock Tips: Exercising Caution

1. Recognize the signs of a top

Whether it is tulip bulbs in 17th century Holland, gold in 1849, or Beanie Babies and Internet stocks in the 1990s, any time a crowd has unanimously agreed that a certain investment is a "can’t lose" opportunity, you are probably best off to avoid that investment. The tide is likely to soon turn. Also, when you see people making investments that they have no business making (think bellboys giving tips on bonds, auto mechanics day-trading stocks in their shops, or successful doctors giving up medicine to "flip" real estate), that’s also a sign to search for the exits.

Things To Know

  • When a crowd has agreed that a certain investment is a "can’t lose" opportunity, the tide is likely to soon turn.
  • Great investors are willing to go against the grain.

2. Look for quality

If you focus your attention on companies that have wide economic moats, you will find firms that are virtually certain to have higher earnings five or 10 years from now. You want to make sure that you focus your attention on companies that increase the intrinsic value of their shares over time. These afford you the luxury of being patient and holding for a long time. Otherwise, you are just playing a game of chicken with the stock market.

3. Don’t buy without value

The difference between a great company and a great investment is the price you pay. There were many fantastic businesses around in 2000, but very few of them were attractively priced at the time. Finding great companies is only half the equation in picking stocks; figuring out an appropriate price to pay is just as important to your investment success.

4. Always have a margin of safety

Unless you unlock the secret to time travel, you will never escape the inherent unpredictability of the future. This is why it is key to always have a margin of safety built in to any stock purchase you may make—you will be partially protected if your projections about the future don’t exactly pan out the way you expected.

Having a margin of safety is a recurring theme among several great investors. This is no accident; margin of safety really is that important.

5. Think independently

Another common characteristic you will find is that great investors are willing to go against the grain. You should find zero comfort in relying on the advice of others and putting your money where everyone else is investing. Quite simply, it pays to go against the crowd, because the crowd is often wrong.

Also remember that successful investing is more about having the proper temperament than it is about having exceptional intelligence. If you can keep your head while everyone else is losing theirs, you will be well ahead of the game—able to buy at the bottom, and sell at the top.