Let's assume you found a stock that meets all of your criteria and fits our
. Before you pull the trigger, we need to discuss your relationship with this stock.
That's right, whenever you buy an equity, you enter into a complex relationship -- with the stock, the company, its management, even your fellow shareholders.
Before your purchase, you are still in a flirtatious stage -- you have no history with the stock and therefore no baggage. That's the time -- before you get in too deep -- to lay out some ground rules governing this relationship.
What you need is a pre-nuptial agreement with the stock.
There are several reasons to create a document governing your affiliation with a stock.
The first is objectivity: Once you own something, you lose the ability to take a cold-hearted look. You've become invested in the company, literally and figuratively.
After you've (hopefully) invested serious time and energy before deciding to make a purchase, you become emotionally invested in the trade. Emotions are the flip side of objectivity, and they rush in to fill the void when objectivity is lacking. A stock isn't
, but you would be surprised at how hard it is to make a clean break. (A
detailed the danger of emotions.)
By having a clearly defined set of parameters regarding how long you are going to hold the stock, and under what circumstances you will "file for divorce," you avoid making emotional decisions to either sell too soon or not at all.
The second reason is discipline, one of the keys to successful investing. All traders know that without discipline, even the best investment plan is worthless. In the classic investing book
by Jack Schwager, the theme of discipline comes up repeatedly in interviews with traders of all sorts: commodities, stocks, currency, futures and fixed income.