The Red Dress Story

Investing in the stock market is really no different from running your own business. Investing is a business and should be operated as such.

Assume you own a small store selling women’s clothing. You've bought and stocked women’s dresses in three colors: yellow, green and red. The red dresses are quickly sell out, half of the green ones sell, and the yellow ones have not sold at all. What do you do about it?

Do you go to your buyer and say, “The red dresses are all sold out. The yellow ones don’t seem to have any demand, but I still think they’re good. Besides, yellow is my favorite color, so let’s buy some more of them anyway,”? Certainly not!

The clever merchandiser who survives in the retail business eyes this predicament objectively and says, “We sure made a mistake. We’d better eliminate the yellow dresses. Mark them down 10%. Let's have a sale. If they don’t sell at that price, mark them down 20%. Get our money out of those ‘old dogs’ no one wants, and put it in more of the hot-moving red dresses that are in demand.” This is common sense in a retail business. Do you do this with your investments? Why not?

Everyone makes buying errors. The buyers for department stores are pros, but even they make mistakes. If you do slip up, recognize it, sell, and go on to the next thing. You don’t have to be correct on all your investment decisions to make a good net profit.

Now you know the real secret to reducing your risk ans selecting the best stocks: Stop counting your turkeys and get rid of your yellow dresses!

--- William O'Neil (2002). How to Make Money in Stocks (3rd Edition, p.96).