They may look like a great investment at first, but if you’re always looking for cheap stocks to buy, you’ll likely end up with losers

Investors who “bargain shop” for cheap stocks to buy may explain that they are simply looking for stocks like a smart consumer would buy a car. But they overlook one key difference. Car prices do vary, and some buyers do pay less than others, because they have better bargaining skills and more time to spend shopping around.

However, the stock market is more efficient than the car market, as an economist would put it. You can’t negotiate a favourable price for a stock. To get a lower price, you have to wait for the stock’s price to come down.

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Always aiming for a deal when you’re looking for cheap stocks to buy won’t likely pay off

Two-part investing exposes you to a double risk. Seemingly attractive stocks can drop for months, or even years, before a hidden flaw comes to the surface and explains their weakness.

For that matter, little-noticed stocks sometimes rise for months before the reason for their strength becomes apparent. In a lifetime of investing, you’ll choose both kinds of stocks.

If you always try to buy below the market, you’ll always get a “fill” on stocks with hidden flaws. They’ll always come down into your buying range ….and they’ll keep on falling.

But you’ll almost never get to buy the other kind of stock—the kind that keeps going up. These stocks will always seem too expensive, and they’ll go on to get even more expensive. But you need a few of these ever-more expensive stocks to offset the losses from those that get cheaper and cheaper.

There’s no easy answer to the buy-now-or-wait dilemma. At times it may pay to hold off—for instance, a company’s stock will often rise when it announces a stock split, then fall after the split takes effect.

In the end, if a stock is truly worth investing in, you should be willing to buy it at current prices, even if that means you run the risk of having to sit through a 5% to 10% setback. Before it slips into its next 5% to 10% setback, after all, it may first go up 50% to 100%.

Seemingly cheap stocks to buy can harbour hidden risks

You have to learn a lot of things to become a successful investor, and few people learn them all in any logical progression. Instead, most of us move from one subject of interest to another, with a lot of zigs and zags in between.

That’s why some investors go through a phase when they know just enough about a particular investment to be a danger to themselves and others.

All investments come with a mix of risk and potential reward. The greatest danger comes when you understand the mechanics of an investment, but you’re missing some of the details. Your understanding of the potential reward can make you greedy, while the gaps in your knowledge limit your natural, healthy sense of skepticism.

Promoters of speculative systems exploit this all-too-human failing in their advertising.

Apply this successful 5%-10% rule for safer investing that includes cheap stocks

Every case is different, because each individual has different investment objectives, acceptable risk levels and so on. But you should generally hold on to high-quality stocks, even if they have doubled in price. However, you may want to consider selling part of some stocks you own if they go way up and come to make up too much of your portfolio—say, more than 8% to 10%. In that case, it may make sense to take partial profits.

In investing for our clients, we rarely put much more than 5% of a portfolio into any one stock. But if a stock does so well that it comes to represent 10% of a client’s portfolio, we at least consider selling part of it, to cut the risk.

You also need to consider your diversification across most if not all of the five main economic sectors. For example, if your exposure to the Resources sector now exceeds, say, 30%, then you may want to sell some of your Resource holdings, to cut risk.

To do that, start by selling any lower-quality Resource stocks you own, while hanging on to high-quality issues.

When you look for the best undervalued stocks today, focus on shares of quality companies that have a consistent history of sales and earnings as well as a strong hold on a growing clientele.

High-quality value stocks like these are difficult to find, even when the markets are down. But when you know what stocks to look for, you can discover them.

Do you look for cheap stocks to buy or do you avoid them because they look speculative or lack of a track record?

Some cheap stocks have potential; many are money-losers. If you’ve lost money on cheap stocks, what did you learn from the experience?