I heard an interesting take on investing the other day. It went along the lines of "never buy [a stock] after a new high, and never sell after it plunges." This advice sounds innocent enough, but it's terribly wrong.
In fact, I'd argue -- and there's a plethora of studies to support this -- that if investors did the exact opposite of this -- buy when a stock is making new highs and sell after it tanks -- they would achieve far better results in their portfolio.
But here's the thing... usually, you're not going to convince the average investor to buy a stock after it hits a new 52-week high. They'd likely try to convince you to sell and book your profits.
That's because this notion of buying a stock at new highs goes against nearly every fiber in our body. It's been ingrained in our psyche that we need to "buy low and sell high." Investing, however, isn't that simple.
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For most, buying a stock at a 52-week high is like standing in the middle of a jungle, machete in hand, and you are now required to pave a new path. It can be scary because you're not sure if the path you're about to pave is the correct one, or if it's headed toward a cliff, or if you'll end up in the promised land.
It's much easier to "see" the path from the 52-week low, because you believe that path is headed back toward the 52-week high. But that's not always the case, and if does happen it could be a tough, long, windy trail back to the top.
Take it from me…
Learn From My Mistakes
Let me show you what I mean with a personal trade back when I was more of "buy-and-hold" investor.
Like many, I thought that buying near a 52-week low was the smart thing to do. It just seemed more "value-like." Plus, I could see the path back to the 52-week high, which in my head was going to score me a quick 50% gain…
I bought shares when they were trading about 35% off their recent 52-week high. Six months later they were in a slide. I was down 17%. Then the shares clawed their way back above my purchase price. As I was reflecting on the path back toward that 52-week high... shares tumbled more than 26%.
But never sell after a stock tumbles, right? Wrong.
Had I been using the Maximum Profit system, I would have cut my losses and moved on… but I wasn't, and I didn't.
Eight years later here's where shares stand…
At one point, I was down 90%. That means in order to just get back to my original investment, I needed to book a gain of 1,000%. That's no easy task.
My publisher doesn't want me to share stories like this. In fact, when I've talked about how I didn't follow my own rules and lost money in the past... well, let's just say that he wasn't too happy.
Sure, I could tell you about my successful trades, how I've booked triple-digits with this stock or that stock. Or how, literally this week, I bought a stock that was at an all-time high, even as pundits were talking about how "this could be the top."
And guess what... I bought because it had great momentum and I'm up more than 12% in two days.
But enough of that. I would rather tell you about my failures so you can learn from them. So you don't make the same mistakes that I did.
I want you to make money. I want you to be successful at trading. And in order to do that, you also must understand that you're going to make mistakes. Not every investment will be a winner. That's okay... as long as you don't let it turn into a giant loser. Cutting a loser short is a victory -- a victory against a larger loss.
Long-time Maximum Profit readers know that I talk a tremendous amount about risk and risk management. That's because if you blow up your account, you won't have the opportunity to take advantage of the next trade. As the saying goes, live to fight another day.
(This article originally appeared on StreetAuthority.com.)