We go to the market, we go to the coffee shop, we go to restaurants; every now and then if you are hanging out together with other fellow investors, you will definitely discuss about stocks and have heard, “This is a good stock! The share price will go up!”. Sounds familiar? This is even exacerbated with the use of social media websites and platforms offering stock tips and unverified news.
Very often you might be getting a hot stock investing idea anywhere from Facebook or even from any open sources. The predicted upside, particularly on the share price, always causes the excitement by pulling you, as an investor getting into the investment. Investor tends to focus on the potential gain in price difference and put aside the hidden risk he or she might be exposing to.
However, it is very important to not fall into this trap of herd mentality and invest just based on hearsay. “This stock’s price will surely go up!” Seriously? We cringed every time we hear someone say this. The first thing you should ask yourself is what is the basis or justification for this particular company to perform so positively which causes its stock price to increase in the future. So, how could you protect yourself risking in stock investing?
Here are a simple 3-way-system to protect the downside in stock investing.
1. UNDERSTAND THE BUSINESS YOU ARE BUYING
“Never invest in a business you cannot understand.” – Warren Buffett
A simple yet cliché advise but with utmost importance. First, you have to be aware there is an underlying business behind every stock. Investing in a stock requires you to believe in that business’s potential to grow in value over time. But, pure believing will not make you money. It must be backed by the knowledge about the company, the business strength, its management and its future outlook. If you randomly invest in a business without understanding it, you are putting your hard earn money in risk and pray hard for it to turn out well. In other word, this is a kind of gambling. It comes with a lot more risk than investing.
2. INVEST IN BUSINESS WITH GOOD TRACK RECORDS
“Know what you own, and know why you own it.” – Peter Lynch
True. Past performance may not be a good indicator for future performance, but a company’s proven business model in the past is a lot more likely to continue propelling towards growth in value over the years. For example, an ABC company can consistently generate a high profit margin with good maintenance of business expenses, it proves that the product or service users are happy with what the company is providing. If the business continues to replicate the way its business has been doing, its future would not be worrisome.
3. BUY IT CHEAP
Yes, buy a business cheap. A cheap business does not equal to a quality business. A business with good quality must come first and we want to buy it cheap! Imagine that you are in the supermarket, strolling down the aisles picking the groceries for your week ahead and you discover that one of your favourite ice-creams is on sales, let’s say down to just $4.90 per litre from the usual $9.90. What would you do? Most likely you will load up your cart while it is cheaply priced. When you return to the next week and see your favourite ice cream priced at $10.90, you make a second thought. This is how most of us shop in the supermarket. Apply the same technique as what you normally do for the groceries while investing in a good quality and high value business, buy it when it is cheaply priced by the market.
Not only that, buying it cheap provides you a concept of what we called “margin of safety”. This idea of margin of safety is sort of like building a bridge for a 1-ton lorry to cross but can withstand up to 3 tons. When it comes to stock investing, buying it cheap provides you some protection in case you made an error in your judgement, bad luck or extreme volatility in an unpredictable and rapid changing world.
THE BOTTOM LINE
“The individual investor should act consistently as an investor and not as a speculator” – Ben Graham
There are so much excitement in the stock market about the upside but it’s equally important to take care of the downside too. You must now understand that investing should not be in relation to hope, prediction or with anyone’s feeling but very much on how you can control the risk by having the facts to support your investing decision. Investing is more intelligent when it is most business-like. Continuous learning will further protecting yourself and having a long-term success in investing.
Disclaimer: All facts and opinions presented are for educational purposes only. This is not a recommendation to buy or to sell. The author involved in the writing of this message has no vested interest in the companies. Please consult a professional for expert financial or other assistance or legal advice.
This article was written by Team VIC
Team VIC is formed by experienced and well-trained individuals from Value Investing College (VIC). The team has been consistently studying the latest stocks market trend in order to focus on educating the layman on investment principles and techniques.