What approach does a person take to begin investing in stocks?

Keep it simple and follow some easy rules.

Actually, since so few investors are following these rules, I call them "Secrets":

Secret #1: Buy when the stock is moving up –
Don’t hold a stock when it’s moving sideways or going down.

I can hear you saying “I know THAT! Everybody knows that.”

Great, so if everybody knows that, why are only 5% of investors actually doing it?

The most popular stock trading strategy is to buy and hold a stock for a looooong time and strongly believe (or hope) that in the long run the stock market will go up. That's what I call the "Showtime Rotisserie Strategy” ¬- Just set it and forget it.

Let’s take a look at an actual example: DELL Computer Corporation. Pull up a chart of DELL and try to follow me here. As you can see, the price of the stock was around $30 in the beginning of 2006. It went down as low as $20 and is currently trading at $23.78.

So let’s take a look at the performance of the "Showtime Rotisserie Strategy” assuming a $10,000 account:

Bought 333 shares of DELL in January 2006 for $10,000.00
Current value of 333 shares of DELL at $23.78 $ 7,918.74
Loss $ 2,081.26

That’s a loss of almost 21% (!!!).

Yet most financial advisors will support this belief by telling you that this is great strategy. They add some fancy words and call it “dollar cost averaging”.

Note:
”Dollar Cost Averaging (DCA) is an investing technique…. According to this technique, shares are purchased in a specific amount on a specified periodic basis (often monthly), regardless of current performance.” (Source: Wikipedia)

“Regardless of the current performance” – That’s interesting, isn’t it?

Let’s take a look at our example:
Let’s assume that now instead of investing $10,000 in the beginning of January 2006, you are investing $2,500 each quarter. Here’s the breakdown:

Bought 84 shares @ $29.75 on March 31st 2006 for $2,499.00
Bought 102 shares @ $24.46 on June 30th, 2006 for $2,494.92
Bought 109 shares @ $22.84 on September 30th, 2006 for $2,489.56
Bought 97 shares @ $25.71 on December 31st, 2006 for $2,493.87
Total Investment $9,977.35
Current Value of 392 shares @ $23.78 $9,321.76
Loss $ 655.69

Wow, that’s much better, isn’t it? Now you “only” lost 6.5%!

Now let’s take a look at the chart again and apply our “secret:”
Buy when the stock is moving up –
Don’t hold a stock when it’s moving sideways or going down.

As you can see, we don’t want to own the stock for most of the year. With our trading strategy, we would have bought it in the beginning of October and just held it until end of December:

Bought 430 shares @ $23.25 on October 6th, 2006 for $ 9,997.50
Sold 430 shares @ $25.04 on Dec 29th, 2006 for $10,767.20
Profit $ 769.70

Let’s compare:
"Showtime Rotisserie Strategy” $ 2,081.26 Loss
Dollar Cost Averaging $ 655.69 Loss
Our “Secret” Strategy $ 769.70 Profit

As you can see, it is common sense to buy a stock only when it is going up, but only 5% of investors are actually doing it.

Why?

Bear with me, I’ll explain it to you in a couple of minutes.

But first let’s talk about

Secret #2: ALWAYS know when you exit–
Know when to exit with a loss, and when to exit with a profit

That’s where the rubber hits the road. Let me tell you this important concept:

Paper Profits are worth NOTHING!

What does that mean? – It means that your profits only become profits when you actually SELL the stock and put the profits into your bank account. As long as you still hold your stocks, these profits are “unrealized profits” and can disappear within a few days.

Here’s an example:

Let’s say you were smart and applied secret #1 to GM (General Motors). You invested $10,000 in GM in May 2006 and bought 383 shares at $26.09.

In November 2006 you were a very happy camper: GM went up and your shares are now worth $13,489.26! You knew (even without your calculator) that you just made around 35% on your initial investment of $10,000. You want to reward yourself and ordered this nice 60” Flat screen that they had on sale during the Thanksgiving weekend.

But then it happened: Bad news hit the wire and within 2 weeks GM shares fell 16%. Suddenly your initial $10,000 investment was only worth $11,352, and instead of the 60” Flat screen you now had only money for the 42” version.

Bottom-line:

ALWAYS know when to exit! Paper profits are just that: Profit of Paper.

You should NOT expect to make 50% on a single trade. Here’s the secret that professional traders use: They realize small profits, and they do it frequently.

How do you make 25% profits per year? –
You make five times 5%!

So here’s the “secret” to trading riches:
1. Buy a stock
2. Hold it for a short period
3. Realize 5% profits
4. Do it again!

Ok, now you understood the concept of taking profits.

What about losses?

Same here: Get out quickly!

Don’t wait until the stock goes down 10%... 20%.....30%.... 40%.
Get out when the stock goes down (Remember Secret #1) and wait until it goes up again.

Many investors like to apply a so-called “stop loss.” This stop loss can be expressed in dollar or as a percentage of the current price. As soon as the stock hits this stop, they sell.

As a rule of thumb you should use a stop loss of 2-5%, depending on your risk tolerance and trading aggressiveness. But isn’t it better to get out with a small loss of 5% than seeing your portfolio shrink by 20%.... 30%.... 40% (as in the example of DELL above)?

You bet it is!

Therefore ALWAYS know when to exit!

Secret #3: Pick the “right” stock
Aaaaahhhh, here we go!

Did you ever experience the following situation:
You picked a stock (e.g. INTC – Intel Corporation) and then the stock did not really move. And even worse: At the same time another stock that you wanted to buy (but didn’t) is shooting up like crazy.

Here’s an example:

Take a look at INTC (Intel) and at IBM. While INTC (“your” stock) is just hovering around 21, IBM really took off.
Now, here’s the problem:

Currently there are more than 10,000 stocks traded on US exchanges. So how can you pick the “right” stock; the one that’s going up?

For this task you have to apply some “filters”:
1. Only invest in stocks that are traded on a regular exchange (no “pink sheets”).
2. You should only invest in stocks that traded with at least 15,000,000 shares per week to avoid a manipulated market.
3. Don’t invest in “Penny Stocks” (less than $1.00 per share), unless you like gambling.
4. Make sure that the stock that you want to invest is in a nice up move (remember Secret #1).

Yes, I can hear you saying “That sound easy, but I know that it isn’t.”

Well, you think that it is difficult because most probably you used the wrong strategies. Or maybe you didn’t use any strategies at all, because you liked the idea of the "Showtime Rotisserie Strategy” - Just set it and forget it :-)

Always keep these simple "secrets" in mind when you want to start trading, and don't let "the other folks" confuse you.

Hope that helps.