Some advisors like to use sports or military analogies to describe their investment approach. They see a great stock pick as the equivalent of a touchdown or home run, and a series of them as a successful military campaign. This, however, puts too much emphasis on excitement and glory, and pays too little attention to risk.

In contrast, if we had to compare our approach to anything outside the investment business, we’d choose chess.

(You can learn more about our value-investing strategy for selecting stocks in our new free report, “Canadian Stock Market Basics: How to Trade Stocks and Make Good Investments in Canada.”)

Losing patience can kill your profits

Good chess players never “go for broke,” as the saying goes. Instead, they try to position their pieces so they can profit from the mistakes they expect from opponents who are less talented, less experienced or less patient.

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Successful investors follow a comparable approach. But instead of waiting for an opponent to make an impulsive mistake, successful investors try to arrange their portfolios so that they more-or-less automatically tap into the profit and long-term growth that inevitably comes to well-established companies operating in relatively free and stable economies.

Diversification is essential if you hope to make great stock picks

Great stock picks are always rare and hard to find. That’s why it’s essential to diversify. If you spread your money out across the five main economic sectors (Manufacturing & Industry; Resources; Consumer; Finance; Utilities.), as we advise, you are more likely to own one of those rare stocks that does two to five or more times better than the average stock.

But in addition to diversifying, you will make great stock picks more often if you limit your involvement in trouble-prone areas, like new issues, start-up companies and illiquid investments. And, of course, avoid companies in which you have any doubts about the integrity of insiders.

The details are more involved, but you can sum up how to make more great stock picks quite simply:

• Don’t depend on luck to make money for you or to prevent losses.
• Aim for profits rather than excitement or bragging rights
• Diversify across the five main economic sectors
• Be skeptical of the claims and recommendations of brokers, promoters or anybody else with a vested interest in selling you a particular investment.
• Stay out of trouble-prone areas of the market.

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