News Analysis date published New: 
Friday, September 16, 2011 - 11:00
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Friday, September 16, 2011 - 11:00
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Friday, September 16, 2011 - 11:00

7 Ways Stock Buyers Sabotage Their Own Returns

Friday, September 16, 2011 - 11:00am

Those who are new to investing are just as smart as those who have been around for a long time. The main difference lies not in intelligence, but wisdom -- the wisdom that comes from making mistakes and learning from them.

From Warren Buffett to George Soros, even the savviest pros will tell you their early years were characterized by dubious choices. Their greatest strength now is the ability to always make the wiser move.

Here are seven pitfalls that even the best investors run into. Avoid them and you'll come out far ahead in the end.

1. Chasing performance
When stock prices are surging, it's tempting to jump in and aggressively buy shares in the hope that the strong market gains will continue. Conversely, if everyone else is selling, then it doesn't mean you should mindlessly follow suit. Instead, you should be buying at a steady pace in good markets and bad, ignoring what the herd is doing. Chances are, you'll be buying high and selling low. As I noted a year ago, investors have tended to turn very bearish right before big market rallies.

Since we can't predict where the markets will head, investment advisors suggest dollar-cost averaging, which means buying a steady amount on a consistent basis, whether markets are rising or falling.

2. Following hot tips
That great investment idea you just heard about has probably been circulating on traders' desks for a number of weeks and is already stale. Instead, do your own homework and make sure you really understand a stock before making a decision to buy.

Sure, a few hot tips may take off, but the vast majority will not. My portfolio never grew in value until the day I stopped buying other people's "can't miss" stocks and started researching my own.

3. Not letting your winners ride

This one has been a hard one for me. I would always instinctively sell a stock after it had risen by a healthy 20% or 30%, only to discover a year or two later that the stock had gone on to rise another 50% or 100%. So if a stock you own is making a steady upward move, then it often pays to hang in there and let it run its course. Only sell if you believe the stock price is now fairly valued or overvalued.

4. Investing in a flaky company
You buy a stock for a fixed set of reasons. Perhaps you're expecting big things from a soon-to-be-released product. Or maybe you anticipate management's new cost-cutting plan will unlock profits. If those events fail to develop as planned and management starts talking up a completely different plan, then it may be wise to sell the stock and move on.

Companies that always offer up excuses for why plans didn't pan out (and quickly come up with a new plan) tend to perpetually frustrate investors and never really gain a following among big investors.

5. Buying when insiders are selling big blocks of stock
Insiders, like company executives and board members, often hold lots of stock, so it's normal for them to sell from time to time. But if several sell at once and in large volumes, then don't jump in until you know why. As I've mentioned before, heavy insider-selling can be a sign that the people who know the most about the company are concerned the stock price may have already run its course, or bad news may be coming.

6. Buying an IPO before its lock-up expiration
When a company files an initial public offering (IPO), company insiders are required to obey a "lock-up agreement" that prohibits them from selling their personal shares for six months. After the agreement expires, insiders tend to flood the market with their shares, resulting in a lower share price.
This trend is pretty predictable. Even the big-time investors who bought into the IPO early will sell their shares a week or two before the "lock-up" expiration so they don't get caught in the upcoming price drop.

If you really like a post-IPO stock such as LinkedIn (NSYE: LNKD) or Pandora (NYSE: P), and it has been four or five months since the IPO, then you're best off waiting to buy the stock until after the lock-up expiration, when the selling pressure has abated.

7. Not watching the company's peers
Investors tend to focus on a particular company without paying enough attention to the broader industry or its peers. Often times, a rival company can provide clues to changing market conditions that will eventually affect your stock.

You don't have to be caught off guard when your company finally announces it's dealing with a major industry change. If you follow the company's peers, then you'll already know the change is coming, and can buy or sell before the herd.

Action to Take -- > One of the great facts about investing is that everything seems to repeat itself. And over time these lessons become intuitive.
I've followed certain stocks through several bull and bear markets, through periods of economic expansion and economic contraction, and have developed a very clear sense of when a stock becomes a clear buy and when it become a clear sell. Pair these tools I've mentioned above with the wisdom you'll accumulate, and soon your performance will start to mirror the results of the industry pros.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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