Why Some Investors Always Profit

Investor analyzing stock market investments using a laptop and a smartphone
••• Witthaya Prasongsin / Getty Images

Some investors typically lose when they trade stocks. Maybe this is even happening to you, where it seems like any investment you make instantly starts moving in the wrong direction.

The majority of investors do about average in terms of overall performance. If the market goes up 10%, they might make 8% or 12%, but they're basically in line with the greater trend.

Yet then there are also those investors who seem to consistently and routinely make profits trading stocks. What is it about their approach, which seems to pay off continually? What are they doing differently than the majority of people we mentioned earlier?

Well, their consistently successful approach to buying and selling shares probably sounds something a little bit like this:

  1. Have a Plan
  2. Developing Rock Solid Rules
  3. Continually Learning
  4. Stop Loss Limits
  5. Proper Position Sizing
  6. Watch Financial Trends in the Economy and Industry
  7. Controlling Emotions and Avoiding Impulsiveness
  8. Adjusting the Plan and the Rules
  9. Staying the Course

Have a Plan

If you don't know where you're going, any road will take you there. Having a plan is important because it will keep you on track and allow you to gauge your progress.

Only with a trading plan will you be able to identify and illustrate which aspects of your trading approach are paying off. Which parts are helping you move towards the destination you desire?

Your plan should include realistic criteria, such as:

  • Types of investments (prices, industries, company size, etc.)
  • The time frame you intend to hold the stock
  • Volatility (Beta) of the shares
  • Risk profile (how risky or speculative of an investment is it?)
  • What degree of potential gains/profits do you expect from EACH stock?
  • Which sources of information will you use/trust?

You should keep close track of the investments you have made, and your reasons for making each investment. Track the results in terms of any profits or losses. This oversight will help you see which types of trades have been most profitable for you—which in turn helps you adjust your plan further as required.

Developing Rock Solid Rules

You absolutely must have trading rules. It will be difficult to fully express the importance of this aspect of "the new investment you," so let's just state it again: you absolutely must have trading rules.

For example, you decide to never invest in foreign market companies, those companies which have a share price of less than $2, or shares of certain industries or have certain debt loads or revenue amounts. It could be anything really and must be developed and adjusted over time. Keep the purpose in mind always—to protect yourself from those bone-headed mistakes we all make from time to time.

Once you make a rule, you absolutely must stick to it 100%. You can adjust the rules as you go based mainly on the types of results you are achieving with each type of trade. By tweaking them as you learn and perform, you will continually strengthen your strategy and protect yourself, while you search for profits.

Always Learning

Even if you've been trading penny stocks since you were 14-years-old and had been leading the industry for low-priced, speculative stocks in just about every aspect, you will learn new things every day (or you should be).

In other words, your journey to becoming a great investor involves continuous and endless learning. The more new approaches you absorb and the more strategies, protocols, and information you digest, the more frequently your investment approach will pay off.

Stop Loss Limits

One of the most important and effective trading tactics is to use stop-loss orders to mitigate any downside risks. Simply put, if you buy shares at a certain price, you choose a stop-loss limit price, which is about 3%, 5%, or maybe 8%, below the level at which you bought the shares. For example, if you bought shares at $102, you might set your stop-loss "trigger price" at $99.

Then, if the shares fall to that trigger price for any reason, you immediately sell. This way, you limit your maximum downside to a small amount, perhaps about 3%, 5%, or 7%.

You can take a lot of small losses on bad trades before it's going to matter very much. Meanwhile, you are avoiding the more calamitous declines, which sometimes see shares falling 50%, 75%, or even 100%.

As well, using stop-loss orders and loss limits as described, keeps you invested as long as the shares do not drop to your trigger price. That way, you remain "locked-in" to the investment, such that you enjoy the profits if the shares start moving higher.

For example, you buy shares at $3 (and set your stop loss at $2.75). If the investment falls towards $1.12, you already sold at $2.75 (and lost only 8%). However, if it goes up towards $4 or $5, besides having protected your maximum downside risk, you still benefited from all the gains.

Proper Position Sizing

Position sizing is about making sure that each investment you make is a safe and appropriate size. Appropriate means that no aspect of your portfolio is too heavily invested in any one stock or asset.

If you have a portfolio of $10,000, and you put $8,000 into a single investment, that is very poor position sizing. More likely, a $10,000 portfolio makes sense to have 10 different investments. This strategy limits each of those purchases to only 10% of the portfolio while diversifying across various assets. 

If you had a portfolio of only $2,000, it would be poor position sizing to have 25 different investments. The commission rates to trade the stocks would be far too great on a percentage basis—25 buys with $10 trading commission on each means $250 (or 12.5%) of your total portfolio gone in JUST commission fees. Then there are also 25 more commission charges coming when you eventually sell each stock.

Thus, to position size appropriately, you need to limit exposure across various assets so that you do not have "too much" exposure to any one asset. Take into account risks, diversification, the commission costs in terms of percentage, and the total portfolio size.

Watch Financial Trends in the Economy and Industry

Watching financial trends is similar to the "continuous learning" mentioned earlier. If you are investing heavily in a digital printing company, then you need to understand the digital printing industry, as well as assess how social and economic trends might affect the company in question. 

Likewise, if you want to be involved in biotech, you should keep a close watch on all the events going on in that industry or particular space. The same goes for oil production, air travel, consumer discretionary companies, base metal mining, retail, and so on.

Read industry publications and watch broad-based financial data as closely as possible. If the Federal Reserve is going to raise interest rates, or the government administration is going to launch a massive tax cut, or war breaks out in Saudi Arabia, then you need to be aware of these issues and understand how they affect your investments. Significant events will affect the investments you're making, and your job is to understand how these situations will affect the prices of the shares that you own, in both the short term and the long term.

Controlling Emotions and Avoiding Impulsiveness

Keeping control of your emotions is easier said than done, but it is so important to control your emotions when you trade. Do not put all your hopes and ambitions into any one particular stock, and don't get married to it in your mind.

Investing well is boring and devoid of emotions. If an investment is not acting the way that you hoped that it would, you need to be able to dump those shares immediately without giving a second thought.

You also should not hold shares that cause you to be stressed out or those that cause you to lose sleep. In any such event, those may not be appropriate stocks for you.

Adjusting the Plan and the Rules

Your trading plan and the trading rules are not set in stone. You should develop them with a lot of thought and stick to them, of course. However, allow yourself the ability to tweak them based on your trading results, and as you learn new information.

For example, perhaps you took losses on three different biotech companies right in a row. You may want to adjust your trading rules to state that you will never trade biotech shares. Or perhaps you do best with sub-$3 penny stocks, and so you might apply more of your focus and resources to that type of investment.

Staying the Course

It has been proven, time and time again, the more active you are as an investor, the worse your trading results. People tend to jump from one investment or trend or fad to the next, without giving their current investments enough time to play out as they eventually will.

Develop a plan, stick to your trading rules, and have the patience required to allow your investments to produce their returns. Businesses, which are what stock prices are typically based upon, take time to grow. They operate in three-month windows, not by the hour, and not by the minute.

Even a company that is growing rapidly and gobbling up market share typically won't illustrate all the financial benefits of that until they release their quarterly results. The quarter is three months, and even the numbers and details from their operations do not become public knowledge until several weeks, or even months, after the end of the quarter.

In other words, you might be finding out that the company is exploding in growth, but not until several months after that quarterly period ends. Typically, many shareholders might have already sold in frustration, then watch as the shares suddenly spike higher just a few weeks later.

Ask Yourself

Be honest, and ask yourself how many of the points above are already a part of your investment approach. The more of them you include in your stock market strategy, typically the better your final results may become.

If you want to invest like those who almost always turn a profit when they buy and sell shares—and you intend to do that consistently—then replicate the points mentioned above. There is a reason why some investors can continually outperform, and now you can see (mimic) exactly how they have that degree of success.