Page 375 - How to Make Money in Stocks Trilogy

250 BE SMART FROM THE START

you should use this more realistic method in the longer-term management
of your portfolio. Doing this more often than once a quarter can only help
you. Eliminating the price-paid bias can be profitable and rewarding.
Any time you make a commitment to a security, you should also deter-
mine the potential profit and possible loss. This is only logical. You wouldn’t
buy a stock if there were a potential profit of 20% and a potential loss of
80%, would you? But if you don’t try to define these factors and operate by
well-thought-out rules, how do you know this isn’t the situation when you
make your stock purchase? Do you have specific selling rules you’ve written
down and follow, or are you flying blind?
I suggest you write down the price at which you expect to sell if you
have a loss (8% or less below your purchase price) along with the expected
profit potential of all the securities you purchase. For instance, you might
consider selling your growth stock when its P/E ratio increases 100% or
more from the time the stock originally began its big move out of its initial
base pattern.
If you write these numbers down, you’ll more easily see when the stock
has reached one of these levels.
It’s bad business to base your sell decisions on your cost and hold stocks
down in price simply because you can’t accept the fact you made an impru-
dent selection and lost money. In fact, you’re making the exact opposite deci-
sions from those you would make if you were running your own business.

The Red Dress Story

Investing in the stock market is really no different from running your
own business. Investing is a business and should be operated as such.
Assume that you own a small store selling women’s clothing. You’ve
bought and stocked women’s dresses in three colors: yellow, green, and
red. The red dresses go quickly, half the green ones sell, and the yellows
don’t sell at all.
What do you do about it? Do you go to your buyer and say, “The red
dresses are all sold out. The yellow ones don’t seem to have any demand, but
I still think they’re good. Besides, yellow is my favorite color, so let’s buy
some more of them anyway”?
Certainly not!
The clever merchandiser who survives in the retail business looks at this
predicament objectively and says, “We sure made a mistake. We’d better get
rid of the yellow dresses. Let’s have a sale. Mark them down 10%. If they
don’t sell at that price, mark them down 20%. Let’s get our money out of
those ‘old dogs’ no one wants, and put it into more of the hot-moving red