This article is part of our Better Investor series, in which The Motley Fool goes back to basics to help you improve your returns and be more successful with your investing.
If you're like most investors, you probably spend the most time trying to find the stocks that will give you the best returns you can get. Yet if you focus only on everything that comes before you actually buy a stock, you're missing out on an opportunity to distinguish yourself from the rest of the crowd -- and you'll leave some potential profits on the table.
Being able to pick out winning investments from the thousands of mediocre and lackluster stock choices out there is obviously an important skill to have. But making a smart buy is only one small part of what defines how much you'll make from your investments. If you start doing the following three things, you'll see a notable improvement in your results as well as your future confidence in making stock picks.
1. Know why you're buying a stock.
Different people research stocks in different ways. But no matter what your rationale is for buying a stock, make sure you fully understand your thinking on it. And in fact, the best thing to do is to start an investing journal and create a written record of your thought process for buying a stock.
For instance, take rare earth metals producer Molycorp (NYSE: MCP ) . One reason that many investors got excited about Molycorp was the fact that China clamped down on rare earth exports, leaving the rest of the world dangerously undersupplied and at the whim of the Chinese political process. Those fundamental reasons spurred private companies like Molycorp and Rare Element Resources (AMEX: REE ) to flourish. But other investors likely got in not because of the company's fundamentals but rather because of the stock's strong price action after its IPO -- action that has now largely disappeared.
By keeping track of why you bought a stock, you can identify which predictions you make turn out to be true. That can help you with future picks when you see similar characteristics that have worked well in the past, or raise red flags if promising characteristics turned out not to prevent losses.
2. Know what your goal is.
Investing discipline requires that you know not only why you bought a stock but also what you hope to get out of it. Depending on the stock, your goals might be very different among the stocks within your portfolio. Moreover, your goals for a given stock might not match up with those of other shareholders.
For instance, with small biotech companies like Human Genome Sciences (Nasdaq: HGSI ) and Dendreon (Nasdaq: DNDN ) , lofty goals of a multibagger investment were long justified, given the binary nature of drug development and the make-or-break profits that typically result. But with other stocks with more mature business lines, more modest goals like solid dividend income and stable share prices are often more appropriate.
The reason it's helpful to keep your eye on the prize is that it keeps you focused on what you expect from a stock. It's all too easy to get swayed by changing market conditions, and when that happens, you can end up missing out on exactly what you wanted from investing in the stock. You can always reassess your goals in light of new information, but tracking and documenting your goals gives you a record you can refer to later, both in evaluating that stock as well as critiquing your performance more generally.
3. Know how and why you'll get out of a stock.
Exit strategies are notoriously hard to develop because you can't predict what will happen to a stock years down the line. If you set too modest a target, then you can end up missing out on the huge long-term returns that top winners like SandRidge Energy (NYSE: SD ) have produced. At the same time, though, a buy-and-hold-forever approach can end up costing you huge gains, as shareholders of Netflix (Nasdaq: NFLX ) and Green Mountain Coffee Roasters (Nasdaq: GMCR ) have recently discovered.
The experience of former high-flying stocks doesn't invalidate buy-and-hold investing as a philosophy. But by including it as a piece of data for consideration, you'll learn about mistakes in judgment that you may make in the guise of being a long-term investor, and you'll be able to choose later on whether you want to take a more active role in watching companies that interest you for the long run.
Get better right now
Discipline is the most important part of becoming a better investor. If you're able to master your emotions and reduce your entire investing process down to a science, then you'll see the improvement in your results almost immediately.
Stay tuned throughout our Better Investor series and get the advice you need to succeed with your investments. Click back to the series intro for links to the entire series.