Growth investing focuses on increasing an investor’s capital, or the amount of money they have. It requires investments in fast-moving growth stocks. These are newer companies that tend to be smaller in size and whose earnings are expanding at an above-average rate compared to their sector or the broader stock market.
Examples of growth stocks include website security company Cloudflare (NYSE:NET), electric-vehicle maker Nio (NYSE:NIO) and exercise bike manufacturer Peloton (NASDAQ:PTON). Growth investing can be exciting, but it’s not without risk. Here, we look at investing principles that investors can employ to help them get rich from growth stocks.
Focus On Relative Performance
Relative performance measures a stock’s performance relative to a specific market or index. Growth stocks tend to outperform the broader stock market. During market downturns, they tend to hold their value. In a bull market, growth stocks tend to soar and outpace other stocks in their sector and beyond. They outperform relative to indexes such as the Dow Jones Industrial Average, S&P 500 and Nasdaq.
Investors with a growth strategy should always buy stocks that consistently outperform the market. Stocks with strong relative performance produce hefty returns for investors. Outperforming stocks tend to stay ahead of markets in good times and bad, week after week, month after month. Watching the performance of stocks and focusing on the ones that are overachieving is a smart strategy.
Pay Attention To Momentum
Momentum is the rate of acceleration of a security’s price or volume. It measures how fast a stock’s price rises or falls. Analysts view momentum as an oscillator. For retail investors, momentum can be like jumping on a speeding train and riding it to the end of the line. As a stock’s price accelerates, growth-oriented investors often buy shares in hopes that the momentum will continue and the price will keep going up and up.
Momentum focuses on short-term movements in a stock’s price rather than on fundamental analysis of a security. Growth investors often use a “trend line” to analyze a stock’s momentum. A trend line is drawn from the high to the low price of a stock over a set period of time. If the line is up, growth investors buy the stock. If the trend line is down, investors sell the stock.
Buy More Shares of Top-Performing Growth Stocks
The saying on Wall Street is “let your winners run.” In other words, don’t sell shares in a stock when the price is trending higher. While holding onto a fast-rising stock is sound advice, it is also advisable to buy more shares of winning stocks over time. When a high-flying stock pulls back or has a correction, investors should view it as an opportunity to buy more shares at a reduced price.
Buying more shares when a stock’s price dips is a smart way to reinforce investments in growth stocks and build wealth over time. This approach requires investors to pay close attention to a stock’s performance and trend lines. It also requires reserve capital that can be deployed quickly when a buying opportunity presents itself. Growth investors should remember that the more money they have invested in a stock, the greater their returns.
Cut Losses Short
While growth investors may want to buy more of their top-performing stocks, they should also not be shy about cutting their losses. Jettisoning losing stocks quickly and efficiently is as important as riding winning stocks to higher returns. And even the most skilled and successful investors buy losing stocks from time to time. Nobody is going to select only winning stocks. The key is to recognize when a stock is moving in the wrong direction and to sell it before the losses compound.
As a general rule, investors should never lose more than 20% of the original money they invested in a stock. And the key is to be willing to sell stocks that underperform. Growth investors who hold on too long suffer greater losses and end up regretting it. Don’t learn the hard way. Sell when a stock loses 7% to 10% of its value, recover your money and live to invest another day.
On the date of publication, Joel Baglole did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Joel Baglole has been a business journalist for 20 years. He spent five years as a staff reporter at The Wall Street Journal, and has also written for The Washington Post and Toronto Star newspapers, as well as financial websites such as The Motley Fool and Investopedia.