by James Brumley

Created on: May 22, 2008

Getting involved in the stock market is one thing. Staying involved is another. Most novice investors quickly learn that financial models and market logic are pushed aside by the market's reality and unpredictable behavior. If they don't learn how to stay in the game by at least preserving their capital, they might not get a chance to become a seasoned investor.

The good news is, taking the investing game to that proverbial 'next level' doesn't require a PhD in economics. Many investors have their all-important 'eureka' moment when they grasp these few simple principles...

1) Stocks don't always trade at what they're worth. If you think a stock's price is always reflective of a company's results, think again. In fact, most gains or losses are made by stocks correcting an undervalued or overvalued situation. Obviously this can work for you or against you, depending on when you buy or sell.

2) Your opinion of a stock's actual worth is just that - your opinion. This is an extension of principle #1, but unless the rest of the market is going to agree with you at sometime in the foreseeable future, an undervalued stock could stay undervalued for quite some time. In that light, investing is as much of an exercise in psychology as it is financial analysis.

One key question to ask is whether or not the investing public would be willing to pay more for these shares later than they're willing to pay now. Does the company and its stock have a compelling history, or will they in the future?

3) When you invest in a company, you're not handing cash over to that company to invest in its own growth - you're giving that money to another investor who doesn't want the stock any longer. Yes, technically speaking you're an owner of the company, but the company doesn't care...they don't receive your investment dollars.

For that reason, being a solid company doesn't necessarily mean the corresponding stock is a good investment. To be a great investment, the company should be tending to their investors and their stock's stature as much as they should be managing their business operations.

So what's the remedy for a sometimes-irrational venture?

There are three solutions to the three potential tripwires listed above.

1) Bear in mind that no matter how much number-crunching you do, investing is still first and foremost an odds game. Not unlike poker or roulette, managing your risk is half the battle.

2) The 80/20 rule applies here too. Approximately 80% of your returns will come from 20% of your stock picks. It can be tough to see 80% of your trades bear little to no fruit, but it's not unusual. Don't let it affect your strategy as long as your bottom line is growing.

3) No stock is a permanent investment. For the same reason investors buy undervalued stocks, investors should be willing to sell overvalued stocks. If it remains a good investment, it can be repurchased after a temporary pullback.

A new investor will often take a scientific approach to stock picking. Once an investor recognizes that it's an art as much as it is a science, their bottom line is apt to start growing.

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