On Wall Street the bulls have been running this spring, carrying the bellwether Dow Jones averages to a series of record highs and encouraging the long-absent small investor back into the stock market. Over the past seven months an across-the-board investment in the 30 blue chip stocks that make up the Dow Jones industrial average would have grown 41 percent. But a note of caution is never misplaced, says Martin Zweig, a stock market player for 25 years and the author of Martin Zweig's Winning on Wall Street (Warner Books, $20). Though his own model portfolio, presented to would-be investors in his newsletter, The Zweig Forecast, would have returned better than 68 percent since the beginning of 1985, Zweig, 43, points out that the market's ups and downs can be treacherous: In order for an investor to win, he also must know how to lose. Speaking with reporter Maggie Mahar, Zweig, who is director of Avatar Associates, managers of $500 million in pension funds, offered some common-sense advice to the investor who would like to wet his feet without drowning.

How much money does the small investor need to start playing the market?

If you have less than $5,000 to invest, I wouldn't buy stocks. If you tried to diversify by buying stocks in three or four companies, too much of your money would be eaten up by brokers' commissions. So you'd have to bet all your dollars on one stock, and that's too risky. With less than $5,000, I'd invest in a mutual fund, which pools money from many investors and puts it in dozens of stocks, diversifying for you. If you have $10,000 to $20,000, you can afford to buy four or five stocks. If you have $20,000 to $50,000, I'd buy eight or nine.

What percentage of an investor's savings should be in the stock market?

First you should build up money-market savings you can get to easily in case you lose your job or get sick. An investor with $50,000 might keep $25,000 to $30,000 in the money market and $20,000 in mutual funds or stocks.

What is the key to investing that stock-market money safely and successfully?

Buy on strength and sell on weakness. In other words, buy when the market looks strong and sell when a stock starts to drop. If the Dow Jones were at 1000 and rose 50 points, that might be enough strength to get me interested in buying. Then I'd look for a strong stock that was behaving well—say a stock that was at $20 per share and had risen to $25.

But what about the traditional wisdom that says buy at the bottom, when stocks are cheap, and sell at the top, when they peak?

That's nonsense. No one can identify the top and bottom consistently. If you try to pick a stock at the bottom and you're wrong, you can get your head handed to you. After you buy it, the stock may just keep plummeting. Back in 1974 the market went down and down and down. Most people think playing the market is like shopping for bargains in the grocery store. It isn't. When you buy a steak on sale, you don't care what happens to the price next week. But when you buy a stock, you're hoping to hold it and make a profit by selling it at some point in the future.

When should you sell a loser?

Whenever I buy stock I place a "stop" order with my broker, which tells him to sell it automatically if it drops to a certain price. I generally say, "Sell when it's fallen 10 to 15 percent."

But if you sell then, you've lost 15 percent of your money. Shouldn't you hang on until the stock goes back up?

No. I face facts. I've made a mistake, so why fight it? Too many people hold on until they've lost 50 percent, and then it's unbearable to sell.

If you're doing well in the market, shouldn't you sell once you've made a decent profit, before the stock starts to fall?

No. Don't sell while the stock is still rising. You don't get rich selling for small profits. Hang on, take all of your profits, and wait until the stock begins to fall. Then sell. Follow common sense: Buy what's rising and looks good. Sell what's falling and looks bad.

But if it's just common sense, why doesn't everyone win in the market?

Ego is a big factor. People buy something, the market starts to fall, and they say, "I'm right. The market's wrong." They try to fight the trend. I have a paperweight that says, "The trend is your friend." That's what pros who have been around understand about the market. If the tide's going to move me, fine, I go with it. If the weather's lousy, fine, I stay home. And I don't want to be the first boat out there when it clears.

What creates an upward market trend?

Falling interest rates. When rates started to come down in 1982, that was a signal the market was improving.

What are the warning signs of a market plunge?

Rapidly rising interest rates. A one percent rise over six months is nothing to worry about. But if rates jump three or four points, worry. Secondly, watch out for plummeting consumer prices. When manufacturers and retailers cannot sell their goods and have to slash prices, that's the sign of a depression. Finally, extreme inflation is a bad sign too. It cripples business.

Can a good broker help alert an investor to trends?

A broker can help, but most brokers are just salesmen, not money managers or market analysts. They'll call you to say, "I've got a great stock for you," but their advice is no better than that of the average investor. If you can, you're better off researching stocks yourself, using a discount broker and saving as much as two-thirds of the commission.

What's the difference between a discount broker and a full-service broker?

You can place a simple order with a discount broker and place stop orders with most of them. But the discount broker just processes your order. He won't call with advice.

Who needs a full-service broker?

If you need some hand-holding, you may want the full-service broker. Sometimes I think it would be cheaper to employ a discount broker and use the savings to pay a psychiatrist.

How does an investor find a discount broker?

I'd pick someone from a firm with a good national reputation, like Quick & Reilly, Charles Schwab or Fidelity. Then I'd check the service by calling them. If the line is always busy, obviously you don't want to use them.

Once a beginner has picked a broker, how does he start researching stocks himself?

Look for the earnings reports that companies announce in the newspapers. Watch for rising earnings.

How much of a rise do you look for?

It could be as little as 10 percent. I'm suspicious if it's too high. If earnings have doubled since the last quarter, that may just mean that the company had one particularly lousy quarter followed by one good one. What you're looking for is consistent long-term growth. Go to the library and ask for the Value Line or Standard & Poor's stock guide and look at earnings over a five-year period.

What else should an investor do before buying a stock?

Look at the P/E ratio—the price of the stock divided by the earnings per share. P/E ratios are listed in the newspapers. If it's too high, the stock is risky. Look for a ratio somewhere between 10 and 20.

What stocks would you pick for long-term investment, as in an IRA?

I'd put the first $2,000 of my IRA money in a no-load mutual fund, meaning one that charges no sales fees. As I built to $10,000, I'd begin to invest in stocks, and I'd invest aggressively. Retirement funds are invested long-term, and the more time you have, the more risk you can afford. Ironically a lot of people put their IRAs in certificates of deposit and savings accounts. Then they gamble with their other savings, trying to grow the money they'll need sooner, which is dumb.

Are blue chip stocks always a good pick for the small investor?

Not necessarily. Today's blue chips may not be solid performers in a few years. Remember U.S. Steel? It was once one of the strongest blue chips, but over the last 20 years it's been a dog.

How about low-cost stocks?

Junk is junk, and you know it when it's priced at $2 or $3 a share. The $15 stock might be a different story, but the $3 stock is a trap for the small investor who thinks, "I can buy 100 shares for $300 and, at worst, lose only a little bit of money." It's just an illusion. He can lose $300, just as if he had bought six shares of $50 stock. Investor psychology is almost impossible to understand. I've been in the market for 25 years now, and I still don't know what makes people tick.