Avoid Stock Recommendations of "Gurus" and Friends

By Dr. Winton Felt

Never make an impulsive stock purchase because the stock was just mentioned on TV, the Internet, or by a friend.  The same applies to selling.  The problem with most investors is that they love a good story and the ideas they get from the Internet or television's market "experts" and "gurus" are often "story stocks" because stories generate interest.  The stock's story gives a person the sense that what he is doing is intelligent.  Everyone likes to think of himself as being perhaps a little more intelligent than the average person.  The excitement that the story generates makes a "believer" out of the investor.  If he invests on the basis of the story, he will have an ego-investment in the idea.  After all, "wasn't it intelligent of me to purchase that stock?  I sure made a good deal that time."  When the ego is involved, it is much more difficult to admit it when a mistake has been made.  When you have not done your own thinking on the purchase, you also have little to go on when it is time to sell.. 

If it was a market "guru" who told the story on television, consider that the "guru" has been buying that stock for some time already.  He or she also wants to look intelligent because he wants more money to manage.  Therefore, he reels off a long list of reasons why the stock is a good buy right now.  Remember that mutual fund managers have an unending supply of new money.  If the stock starts to decline, he can keep buying at ever lower prices and thus bury his timing mistakes.  It would be foolish for an individual with limited resources to average down like that. 

The idea may have come from somebody on the Internet or from a friend.  It gives a good feeling to be "in it" with a friend or with someone who has a reputation.  The fact is however, that such "tips" are usually devoid of one critical element.  They are almost always devoid of precise entry-point timing.  Though the guru says he likes a stock, he rarely defines a precise entry point.  If the stock has a rising trendline that is giving it support, then that line is changing every day.  That means the entry point is also changing.  The entry should be made after the stock has declined to the trendline and has just begun to "bounce" off of it.  Your friend's tip is likely to be even more vague.

When a tip is somebody else's idea, it is difficult to "own" it as your own.  When you come up with your own idea, you have a complete and accurate grasp of why you bought it.  Because you did your own thinking, you also know when the reason for owning the stock at that particular time no longer exists.  You can better recognize when the stock's pattern is no longer compelling.  After all, since the chart pattern helped you define your reason for buying and also your entry point, you should be able to recognize immediately when the pattern has deteriorated.  You should therefore find it easy to recognize when you have a reason to sell.  Our own stockdisciplines.com traders watch a stock's chart carefully, because most of our sell rules are based on behavior that can be observed on a chart.

The beginner should try a few strategies for awhile, perhaps on paper, to find one that fits well with his personality.  By that I mean a strategy that the individual can trust enough to not second-guess it.  No strategy will improve performance if it is not closely followed.  When you think you have found a strategy that works for you, try it with real money long enough to see if you can obey its rules.  Create a small portfolio with only a fraction of your investment assets in it.  Then divide that into ten "baskets."  These baskets will be occupied by stock or cash (for the word "stock" substitute "currencies," "futures," or whatever your investments are if you are not investing in stock).   

Once you have a strategy that works, stick with it.  Never make an impulsive trade because it was just mentioned on TV, the Internet, or by a friend.  The same applies to selling.  You have to be able to believe in your strategy.  You are far more likely to commit an error if you second-guess your strategy or ignore your stop loss signal when it is triggered.