TODAY: Useful Advice From a Trading Veteran

We are proud to introduce Erik Nelson, an experienced investment manager and publisher of a highly-successful investment newsletter.  Erik was kind enough to provide us some of his views on small-cap investing -- FREE of charge!  So, while our in-house Analyst, Doug Rogers prepares another brilliant missive for you, allow us to provide some keen insights from Erik Nelson of Sterling Investment Services Inc.

Over the next several weeks you will receive a series of articles called 11 Rules For Trading - valuable lessons gleaned from Erik's years of experience trading stocks and other securities.  We know you'll enjoy this timely information.

An investment research and money management firm offering high-quality, independent, fundamental research on public companies, financial asset management, and publishes the "Sterling" series of newsletters. 

Erik S. Nelson is the president of Sterling Investment Services, Inc.  Mr. Nelson received his finance degree from the University of Colorado in 1989,  and worked as a retail stockbroker for years before setting up his own hedge fund in May of 1995.  Mr. Nelson has written the Sterling Investment Newsletters since early 1996.  Mr. Nelson traded at Momentum Securities, one of the largest electronic trading firms in terms of daily volume, for 3 years from late 1998 until the summer of 2000.  Mr. Nelson also consults through Coral Capital Partners on mergers & acquisitions and fund raising for small companies.

11 Rules For Trading

From early 1996 until February of 2000,  I published a daily newsletter focusing on short-term trading opportunities.  During that time I developed 11 Rules For Trading to aid my readers and myself in maximizing investment performance.  Over the next few weeks, I'll cover all 11 Rules on the "installment plan" here on StockUpTicks.
 

Rule # 1: Never Let a Profit Turn Into a Loss

This seems to be a very basic concept and one that could easily be followed,  but it is not!  Investors typically have three basic reasons to hold on to stocks that move against them and become losing positions. 

The first occurs when they purchase a stock and it moves down from purchase price.  This causes the typical investor to shift their expectations to recovering their losses rather than maintaining their original expectations.  As a result the typical investor becomes more focused on recovering their losses than monitoring and evaluating the investment on its merits.  This is a very dangerous trap that almost all investors fall into at some point.  The first step in avoiding this is to recognize the behavior.  Then when an investment moves against you,  maintain your focus on the merits of the investment and not on recovering your losses.  Remember your capital may be better employed in a company with better prospects.

The second scenario that causes investors to hold on to money-losing investments typically befalls the investor who occasionally monitors their investments and then suddenly find that they need to raise cash for a persaonl need.  They look at their portfolio and find they have a difficult time selling a stock at a loss.  Selling a stock at a loss would also mean admitting they made a mistake when they bought the stock.  I have seen this on numerous occasions.  Many investors will then sell their better performing stocks to raise the cash they need.  If these investors where running a professional sports team,  say the Chicago Bulls,  it would amount to trading Michael Jordan,  Scotty Pippen,  and B.J. Armstrong during their title runs in an attempt to improve the team!!!!

The third reason that investors often hold on to money-losing investments is blindly listening to the advice of their stockbroker.  Believe it or not,  stockbrokers are human beings and they are vulnerable to making the same mistakes as the rest of us.  They are probably even more vulnerable to the first two scenarios than the rest of us due to the extreme pressure they are under to perform for their clients.   A couple of poor investments can have a severe impact on their careers.  I was a stockbroker for six years,  and I guarantee that not only do clients hold you responsible for the things they should, but they tend to hold you responsible for things that are beyond your control.  I have seen clients hold their brokers responsible for trades that the client picked.  This places tremendous pressure on stockbrokers to present the best possible image to their clients.  This is probably the most difficult situation to correct because it involves managing the reactions of other people.  My advice for investors is to realize that a client should only hold a stockbroker responsible for the things he or she can  control or anticipate.  Additionally, investors should try to encourage more open conversations regarding investment performance.  Learn to question your advisor if your don't completely understand and feel comfortable with their advice.  Don’t get me wrong, this problem doesn't befall all stockbrokers, and there are many excellent ones out there.

My next installment will cover Stop Losses - an often misunderstood investment tool that can help you retain profits and minimize your losses. 
 

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