Buying Stocks the Right Way

Everybody loves the initial rush of buying a stock. It's akin to the feeling spring training brings to each ballclub in major league baseball - Every team thinks they will win. With stocks, there are myriad things to do prior to buying (and selling) that determine your success. Have you done the proper research on the given company? Some important things to know before buying:

  • How does the company make its money?
  • What affects the company's sector?
  • Performance history.
  • Check the competition.
  • Evaluate the balance sheets, 10q and 10k statements.

Alas, as critical as the above points are to making you money, a majority of amateur investors lose money from the second they hit the buy button. Why? Because they have never been taught the actual process of buying a stock from their broker. 

How the Pros Do It

Lets hypothetically say an investor has $3,000 to invest and they like the company Boeing symbol BA. They have done the research and are confident that the aerospace cycle is strong. Furthermore, they understand the company, its competition and have looked at the financials - all of which check out. The decision is made: they want to buy Boeing. The next step most amateur investors make at this point, and where they go wrong, is to buy all their stock at once. 

You may be reading this and saying to yourself, "That's exactly what I do." I know this because I've done the exact same thing even to the point of foregoing the research and buying a stock immediately because I didn't want to waste "crucial" time researching the company. Wow, what a mistake. It's important to remember that patience pays off. When you find a company you like, take the time to thoroughly research it before buying. Inevitably, you will get the chance to buy the stock at a price you want it.

Now, back to buying the stock like a professional. You have your $3,000 allocated to BA and the research is done. It's time to buy. First, observe the stock for several days. Wait for any weakness you see in the stock and purchase your first $1,000 worth. This is called initiating a position. Your not fully invested yet, however, you're on your way. The reason why we don't buy all at once is because we can't game the stock market. Nobody knows day to day exactly which way it will go. So if you invest all your money at once, many times you will be down almost immediately and feel like an imbecile.

Next, contine following the stock on a daily basis. From here three things can happen:

  • The stock doesn't move 
  • The stock goes up
  • The stock goes down

If the stock stays put, continue waiting. With a stock like Boeing that pays around a 2% yield, you are being paid to wait. If the stock goes down 5 to 10% then it is time to put more of your capital to work. There is no set formula stating how much to put down at each increment. Play around with different amounts until you find what works for you. You could purchase $1,000 more of Boeing each time it dropped 5% until you are fully invested. Or, you could wait until the stock is down 10% and then purchase your final $2,000. By purchasing your stock this way you are essentially getting yourself a better basis (meaning the average price you pay for the stock). 

Oh yeah, and what if the stock goes up from your initial $1,000 investment? Well, you made some money! Granted, you may not have been fully invested. Nevertheless, you negated a lot of risk buy not allocating all of your capital at once and you still profited from the transaction. The professional hedge fund and mutual fund managers all purchase their stock this way for a reason. Why try to outhink the room and do it your way?

Market vs. Limit Orders

There is one more vital thing to know about the actual transaction of buying stocks. Limit orders are king. Never ever ever use market orders. Strangely enough, market orders are the most common type of transaction used through brokerage accounts. A market order is an order to buy or sell a stock at the best available price. Usually this type of order will execute immediately, however, markets move extremely fast so you may receive a much higher price than you anticipated. 

A limit order is an order to buy or sell a stock at a specific price or better. You set the limit meaning you get to decide the price that you are comfortable paying for the stock. Furthermore, you can choose for the limit order to expire at the end of the trading day or stay open until it is cancelled by you. Limit orders allow you to be in control, which in the stock market is an uncommon thing. 

Patience in Investing Makes You Money

Building a position in a stock takes time and patience. It would be much easier to put all your capital down at once and be done with it. Unfortunately, most people choose to invest this way and find themselves losing money immediately. Now that you're an informed investor, I am confident this won't be you. Being patient and buying in increments will make you much more money in the stock market then the alternative. This is the way professional money managers trade so shouldn't you do the same?