(04/13/12) 3 Important Tips for Growth Investors

It hasn't exactly been a great market for growth stocks, as income has stolen the show for months, but growth stocks are seeing interest again. So it's important to remember how to maximize your gains while minimizing your risks, writes Michael Cintolo of Cabot Market Letter.

We’ve written about this topic before, but now is a great time to bring it up again. While most investors try to be early to the party (“the early bird gets the worm”), the fact is that in the market, it’s usually better to wait for a clear upturn, even if it seems like you’re missing the move in many growth stocks.

When you buy “early,” there are three scenarios...and two of them are bad.

The first scenario is the one we all hope for: You take a position in a couple of potential leading growth stocks while the market is still trending lower, anticipating a turn higher. And it works! You have a low cost basis in these names, which then average up, allowing you to ride the winners higher.

However, in the big picture, the amount of “extra” money you made by buying early is relatively small—maybe 10% in a position or two, something like that. It definitely helps, but it doesn’t make the difference between a good year and a bad year.

The second scenario is the obvious risk when buying early: The market’s downtrend grows fiercer, and it drives your new purchases into the ground. Because trends tend to persist for longer than most expect, this happens often. Most investors want to buy near the bottom, but every time they achieve that goal, there are usually three or four misfires that cost money.

The third scenario is one that few think about but can still cost you money: You correctly anticipate the market’s turn...but you buy the wrong stocks!

That is, a growth stock that holds up well throughout the correction looks like a new leader and you buy it, but when the bulls return en masse, they buy up other stocks while yours languishes or even sells off. We’ve seen this happen time and again, even when we do wait for confirmation of a new uptrend.

For instance, check out FEI (FEIC), which was one of our purchases in early April 2007 after our Cabot Tides flashed a new buy signal. It had a great, resilient chart, a solid growth story, and big numbers. But the stock stalled out after our buy, we cut our loss and shares eventually went over the falls...despite a buoyant market.

Click to Enlarge

Always remember that your goal isn’t to get in at the lowest price, but to buy when your odds of success (hopefully major success) are highest. (About making great returns, Baron Rothschild wisely once said, “I never buy at the bottom, and I always sell too soon.”)

So, while a small position here or there isn’t going to kill you, it’s better to refrain from starting a major growth stock-buying spree until the trend of the market and most leading stocks turn decisively up.

Subscribe to Cabot Market Letter here...