How to Avoid 3 Critical Investing Traps

In order to succeed in the markets, you have to recognize when you have been trapped in an investment. Then you have to find the strength to sell and move on…

It takes guts to admit you are wrong. As a trader or investor, you will take losses. If you understand that you won�t book profits on every single trade, you will be better prepared when the time comes to part with a loser.

Remember, the deck is stacked against you. The market is not a level playing field. You are an individual investor going up against Wall Street professionals armed with massive amounts of cash, superior tools and access to endless research. You have to plan ahead� and you have to think like a skeptic in order to survive.

That�s why I helped you develop a basic trading plan last week. Since I published the column, I�ve received countless e-mails asking about losing stocks. You recognize that you�re in a bad spot. Or something about one of your investments just isn�t right. But you�re not sure what to do next.

Today, I�m going to use your questions to reveal three critical investing traps. If you learn to avoid these situations at all costs (or sell out and move on to your next idea) I all but guarantee you will quickly become a more successful trader.

Let�s go to the first question:

What do you think about Radio Shack?

� C.P.

Radio Shack (NYSE:RSH) continues to push to new lows. And I�m not just talking about lows on the year. Shares of Radio Shack are actually trading lower than they have in 30 years…

Any way you look at it, this chart is ugly. From a technical perspective, I wouldn�t touch Radio Shack stock with a 50-foot pole. If you ever pull up a chart that looks like this, just run away.

Here�s the trap: an untrained eye might consider Radio Shack to be a �cheap� stock worth a second look. It�s a recognizable brand that�s down big, so it has to recover at some point, right?

Wrong. You can�t assume a stock presents some sort of value opportunity just because its shares have taken a beating. In the case of Radio Shack, the company appears to be in trouble. It�s sales are dropping. The business is under a ton of pressure from online retailers such as Amazon. And the only products the stores seem to be selling are lower margin items.

In short, this �cheap� stock is a trap. Avoid at any price.

I work for a living and I can�t be glued to a computer during the day. So can I purchase a penny stock and put a stop order in and if so what percent would you suggest?

� M.C.

When you are dealing with smaller stocks, stop losses can be tricky. I�ve always recommended �mental stops� instead of a hard and fast stop order. Here�s why…

If stocks have a volatile day, you might get stopped out of a position that immediately recovers from its initial drop. Usually, smaller stocks are not as heavily traded. So shares tend to suffer from large temporary price swings.

That�s where the trap lies.

If a smaller stock drops on lower volume anywhere near your stop loss, chances are it will be taken out, only for the stock to recover and move higher.

As long as you�re not daytrading or dabbling in very small names, you should be able to rely on closing prices for your stop losses. If you have a predetermined mental stop based on where the stock closes, you can easily check the market in the evening. If you have to sell, you can have an order ready to go for the next morning.

There is one tiny company that I�ve been watching for months and while it has won awards and even huge contracts, this stock still sits below 10 cents a share and just seems to sit. Sometimes I�ve seen it jump 20-30% then fall right back down.

� M.R.

The problem here is lack of volume. A stock isn�t going to move if there�s no one interested in buying or selling shares.

Lack of trading volume can trap you in a stock with no way to get out at a reasonable price. I don�t care how well the company is performing � or how nice its chart looks. If no one is trading it, there�s little to no chance of it breaking out.

When you�re looking at smaller stocks, one of the first things you should note is the average volume. I like to see at least 100,000 to 200,000 shares traded every day. And that�s on the low end. Anything less than that can get you into trouble. If you do get trapped in a low volume stock, try to sell at the best price and move on to your next idea.