Wisdom abounds on Wall Street, but not all of it will make you money.
In fact, some of it can lose you money. Most dangerous of all are some of the oft-repeated half-truths that are spread around. Sure, they have kernels of truth in them, but they can often do more harm than good. Let's look at some of the ones you might be most likely to find.
Don't double down
Doubling down is supposed to be one of those things that smart investors never do. That is, you're not supposed to buy more shares of a stock if the price has declined from your original buy-in price. Now, it's certainly easy to oversimplify this particular rule -- doubling down doesn't have to mean doubling the number of shares you hold (or the dollar value of shares you hold), and those who advise you not to double down don't often tell you how much of a decline to avoid. In other words, is it "safe" to buy more shares if the stock is only down 5%, but "dangerous" if it's down 15%? See the trouble already?
Now, it's absolutely true that you don't want to throw good money after bad. So if a fall in the stock price is related to truly bad news and worsening fundamentals, that's when you don't want to buy more. But if the decline seems to be more akin to "one of those things that just happens," you might want to change your thinking. Think about it this way: If you bought a stock yesterday for $20 and it traded down to $18 today for no good reason, why wouldn't you want to buy more of it? If you don't like it now at $18, why did you like it at $20?
But it is critical to distinguish situations where stocks are declining for no obvious good reason from situations where there is either meaningful fundamental deterioration or significant overvaluation. For instance, I "doubled down" on American Eagle Outfitters
Had I doubled down on something like UTStarcom
It's also important not to allow the pursuit of a "bargain" to unbalance your holdings or your risk tolerance. If you already hold a full position, you probably don't want to add too much more to it, just because the price is now a little lower. After all, it feels like you never own enough shares of your best picks, but it always feels like you have just a few too many shares when the story doesn't turn out so well.
Buy what you know
This is another seductive half-truth. The idea makes perfect sense to a point. If you dip into industries that you really don't understand, how can you properly understand the important aspects of the industry and figure out the competitive landscape? If you don't know what's going on, your success is at the whim of chance. And I'm not the least bit embarrassed to admit that I've lost some money here and there by investing in situations where I didn't really know the sector or industry as well as I thought, but "the numbers looked so good."
The trouble is that following this rule too far can artificially shrink your universe of investment possibilities. In some cases, it may discourage you from learning new things and broadening your knowledge base. For instance, Intuitive Surgical
I can't say that I knew all that much about the pawnbroker or debt-collection industries five years ago, but I dug a bit and learned -- and have made quite a bit on my investment stakes in FirstCash Financial Services
So maybe this pearl of Wall Street wisdom just needs to be polished up a bit and reworded -- perhaps to something along the lines of "Buy what you know, but make sure you know more tomorrow than you do today." By all means, you must do significant due diligence and you must strive for a deep understanding of a company before you buy -- but that's a far different requirement than simply sticking to sectors/companies you already know pretty well. It might not always seem easy to learn a new business, but just remember -- nobody is born with any innate knowledge of a business, so everybody had to learn somewhere along the way.
Tune in again
This is just the first installment in my debunking of some of the more pernicious or dangerous half-truths of investing. Tune in again for the second and third parts of the column, where I take on three more myths, including the one that gets my goat most of all.
For more myths debunked:
Fool contributor Stephen Simpson owns shares of First Cash Financial Services, Portfolio Recovery Associates, and American Eagle but has no financial interest in any other stocks mentioned (that means he's neither long nor short the shares).
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