Three Things To Avoid As An Amateur Stock Picker

In 2008, I was living in a tiny, dirty efficiency apartment in the worst part of my town. I couldn't even afford cable. I ate a chicken breast every night for dinner, and most of the time, skipped breakfast and lunch. I was poor.

But six years later, I make more money than any of my friends. I'm the only guy I know under thirty who owns a house a block away from the intracoastal in beautiful South Florida, a boat, and two cars, including a BMW. I bought it all myself.

How did I do it, you might wonder? By picking stocks? Hell no. I did it by finishing a business degree, trying many different things after college until I figured out what I wanted to do, aligning myself with people who could help me and finding a company that could afford to pay a high salary. And then I just worked my ass off.

Sorry to disappoint. Nevertheless, I do enjoy picking stocks. I like scanning the S&P and the Russell for inconspicuous, even obscure companies, looking for issuers that meet some basic criteria. For example, a company that produces a good for which there is a demand, with its financial house in order, and growing revenue and tightly controlled costs.

I've picked some winners, and I've picked some serious losers. This article is about the losers. Here are my top three things to avoid if you want to have "luck" in picking stocks.

1. Don't fall for lies.

Early on in my stock-picking foray, I got in with a company called A-Power Energy Generation Systems (APWR). APWR was a Chinese manufacturer of wind turbines, and by the time I came across the issuer in 2009, their Securities and Exchange filings looked unbelievable. They were striking deals all over the world, dozens of them at a time, raking in millions of dollars every quarter. The balance sheet was impeccable. The stock was trading at five times it's earnings. Between 2009 and 2010, shares jettisoned from $5 a piece to over $30. I rode the lighting. I traded the stock over and over again on the spectacular twelve-month run. 

The last trade I made was a big block purchase of shares at around $28. Within a few days, the share price suddenly shed 20%. Within a month, the stock traded at half that value. People were dumping shares. I unloaded my holdings during the slide from $16 to about $10. And I was one of the lucky ones. Six months later the stock was destroyed, trading for fractions of a penny, and then simply flamed out like a dead candle.

A 2011, a class action lawsuit was filed in the states against the company and major officers alleging massive financial reporting fraud. Settlement was approved by the Court in 2013, which recovered about $3.6 million for roughly 41 million "damaged" shares (before attorney's fees and litigation costs). I haven't yet received my insultingly tiny share of the award proceeds. Click here to learn more about the APWR Class Action and settlement.

If it seems too good to be true, it's because it is. Watch out for companies that cook their books. It happens all the time, but once you've been burned, it's easy to spot.

2. Don't be a day-trader.

Don't do it. You can't do it. Stop trying.

Day-trading "gurus" who tell you that you can be a day-trader, like Timothy Sykes, are all smoke and mirrors. Sykes can make videos of himself and his friends parading around on his private jets, driving fancy cars and eating lobster, and telling you that you can be like him, too - you just have to stop making excuses, and do it! If you think he gets all his money from day-trading, you are a fool. Guys like Sykes run a very simple business model. Build a website and an program that sells an image in return for membership fees and advertising revenue.

Real day-trading is gambling - nothing more. And the problem with gambling in the financial markets, much like gambling in Vegas or Jersey, is that the house always wins. They don't win "sometimes." They always win.

Even if you make a day-trade where you secure a spread on 10,000 shares - say $0.10 - you've got $1,000 in the bank. Right? Well...it's complicated.

Have you considered your broker's commission? Have you considered the capital gains tax implications? Not to mention the qualifying questions: do you even have enough money to safely try day-trading? It requires tens of thousands of dollars to secure the kinds of spreads that can actually pay your mortgage every month, and that's only if every trade goes your way, which is a mathematical impossibility.

What about the opportunity cost of deploying all of that money, and the dozens of other ways you could have put that money to work in a safer, higher-return equity or basket of equities?

If you choose to day-trade, good luck: you're up against some powerful forces who make money regardless of your position in the market. Brokers, institutional investors, flash boys...the list of people who are waiting to take your money goes on and on.

And if you're still not convinced that day trading is a bad investment of your time and dollars, consider this: Warren Buffett is the opposite of a day-trader, and he's the richest guy on the planet. There is no day-trader who will ever in their lifetime accumulate even one-tenth of one percent of Buffett's wealth.

Don't day-trade. Make smart investments into well-managed vehicles that generate solid returns.

3. Put down that penny stock.

Ignore me, if you'd like, on the first two points. But please, please...stop trying to trade penny stocks. You are not trading. You are putting your money directly into someone else's pocket. Penny stocks, or issuers trading on unregulated stock markets, like the OTC or pink sheets, are basically black markets for nowhere stocks. Occasionally, issuers rise out of the pink sheets and onto a real market, like NASDAQ. But that's pretty rare, and it's certainly not going to happen the day (or even the year) you are trading one.

The biggest danger with penny stocks is that there is an unknown degree of risk in the imbalance of knowledge. You have no idea who is holding the shares that you are buying. You have no way of knowing whether that person is actually running the company, or just running their mouth. The content the company publishes is a thinly veiled attempt at legitimizing theoretical values. You don't know if the 10Ks that are "filed" are real or not. You don't know anything about anything that has to do with that stock. 

Sadly, too many people think trading penny stocks is a bulletproof quick road to riches. But the only people that are getting rich, and sometimes illegally, are the stockholders you're buying from. 

Want to become a great stock picker? Avoid fraudulent issuers by recognizing the warning signs, don't attempt to "day trade", and avoid unregulated penny stocks. There's far more to learn, but that's a good start.