Editor's note: One of the keys to investment success is learning to avoid "value traps"...

But value traps are just one of the many pitfalls that can destroy your portfolio.

In today's Masters Series, we're sharing a chapter from our good friend and Empire Financial Research founder Whitney Tilson's upcoming book, due out later this year.

As you'll see, like everyone, Whitney made some mistakes with how he managed his portfolio early in his career. And now, he's sharing a list of guidelines to make sure everyday investors don't fall victim to these mistakes with their own portfolios...

Six Simple Tips to Help You Avoid a Portfolio Disaster

By Whitney Tilson, founder, Empire Financial Research

When I first started investing in the mid-1990s, I thought that all I had to be was a good stock picker to achieve my goal of market-beating returns over the long run.

Boy, was I wrong!

Over time, I learned (mostly the hard way) that portfolio management is just as important as the stocks you pick.

Early in my career, I was so inexperienced that I didn't really understand what it meant to be a portfolio manager.

I simply bought the cheapest 10 or 15 stocks I could find and didn't hold much cash. The thought of short-selling never occurred to me. I was only vaguely familiar with what an option was, and I didn't know a thing about trading on margin.

On occasion, I developed conviction about something like the dot-com and housing bubbles and took some steps to adjust my portfolio accordingly.

But at the end of the day, I was just a plain old bottom-up stock picker on the hunt for a dozen or so cheap stocks, and that was it.

Had I just stuck with this simple approach, I would have done well. Instead, I strayed from that approach. Over time, I made terrible mistakes in every aspect of portfolio management. In today's essay, I'll show you exactly what I learned...

1. Be careful with exposure and margin

Banks and brokerages are generally delighted to lend you money. If you have $100 in your account, they might lend you $50 so that you can buy $150 worth of stocks. This can magnify your profits... and your losses.

Worse yet, banks and brokerages keep a close eye on your account. If your losses start to pile up, they can give you what's known as a "margin call," forcing you to quickly sell and raise a certain amount of cash (or they'll do it for you).

Per the example above, let's say you have $150 invested, and your account falls by 33%. You've lost $50, and your account is now worth $100. But the amount you owe the bank is still $50... So in reality, you've suffered a 50% loss, since you now only have $50 of your original $100 in capital remaining.

A bank is happy to lend you $50 on $100 of equity, but not $50 on $50. Long before your account shrinks by 33%, you're going to get a margin call. That can be a real disaster because you're forced to immediately sell, usually at the exact moment you want to be buying.

This is what happened to me in 2011 when I was running my hedge fund. My business partner and I had allowed our exposures to creep up to 136% long by 63% short that summer. In July and August, the European debt crisis caused turmoil in what had been very complacent markets. In a matter of weeks, the S&P 500 Index fell nearly 20%. Our fund fell even more than this because we were trading on margin, and some of our stocks got hit especially hard.

Normally, that would've been OK. We had a strong stomach for volatility. In fact, we embraced it because it gave us good opportunities to both buy and sell at attractive prices.

Thus, we were eager to take advantage of the sell-off. (Our instincts were correct, as the markets swiftly rebounded.) But at precisely the time we wanted to back up the truck, we were instead forced to sell because we got a margin call in August.

Our fund got crushed, falling 13.9% that month. In total, from July through September, we were down nearly 26%, nearly double the loss of the S&P 500. It took us years to dig ourselves out of the hole we had created.

2. Limit your number of positions

The next tenet of proper portfolio management is limiting the number of positions you own.

At our peak, we were wildly overdiversified with 41 long positions and 87 short positions. Even two experienced investors like us couldn't possibly have a deep knowledge of and closely track that many positions.

You don't need to own more than 10 or 20 stocks. That's a good number to be reasonably diversified, while also being concentrated in your best ideas.

3. Size positions carefully

Another mistake we made was position sizing.

We had oversized positions in some of the riskiest companies in our portfolio, most notably a 14% position in clothing retailer JC Penney, an 8% position in satellite company Iridium (IRDM), and a 5% position in Spanish media firm Grupo Prisa.

In general, I've found it's best to put no more than 5% or 6% in even the bluest of blue-chip stocks. For smaller, off-the-beaten-path stocks, I recommend sizing them even smaller, in the 3% to 5% range.

4. Resist the temptation of investing in options or private companies

Making matters worse, in addition to being wrong on the three stocks I just mentioned, we owned nearly half of our JC Penney position in the form of call options and all of our Iridium position via warrants.

The latter was especially deadly... At the end of 2011, Iridium's stock was trading at $7.71. The warrants had a strike price of $7, so we were 71 cents "in the money." They traded above this level – at $1.72, reflecting the time value of the warrants – but tended to move almost penny for penny in line with the stock. Thus, modest moves in the stock price led to big moves in our 8% warrant position.

We didn't dabble too much in private investments, fortunately – but what we did do, we regretted. In 2008, we set up a small side fund to invest in the stock and warrants of special purpose acquisition companies ("SPACs"). This worked out OK, but it wasn't worth the trouble, and later it saddled us with two of our worst investments ever (Iridium and Grupo Prisa).

In 2011, we invested in a side fund that hedge-fund manager Kyle Bass of Hayman Capital had set up to bet on rising interest rates and a weakening yen in Japan. Over three years, he doubled our money, but it came with a lot of volatility, total illiquidity, and forced us to delay sending K-1s to our investors.

Lastly, later that year, we invested in a privately owned insurance company. After a promising start, it turned into an unmitigated disaster, incinerating our capital and giving me plenty of gray hairs along the way.

It's easy to get lured into making any number of dangerous bets with your money. The vast majority of investors would be better off never touching options or investing in private companies. But if you do, be sure to do your due diligence and size your positions carefully.

5. Resist the urge to over-trade

As we got into a hole, we ramped up our trading, churning the portfolio. Our goal was, of course, to turn around performance. In reality, we only made things worse.

Countless studies show that the less trading you do, the better your returns are likely to be. Here's a funny story that underscores this point to an extreme...

Nearly two decades ago, my sister set up a retirement account at the company she worked for at the time. Every two weeks, she had money withdrawn from her paycheck and automatically invested in the S&P 500.

Then, she switched jobs and forgot about the account, so she didn't make a single trade or investment decision for more than 15 years.

She recently switched jobs again, which reminded her to check that old account. She contacted her former employer's human resources department and discovered that it had compounded into a small fortune.

The irony is, had she remembered she had the account all along, she probably would have done something dumb like sell and go to cash at the market bottom in 2009.

6. Know when to add to, hold, trim, or exit your positions

The most important – and most difficult – element of successful portfolio management is knowing when to add to, hold, trim, or exit your positions.

I didn't do this well. In 2011 and subsequent years, I rode my positions in JC Penney and Iridium lower and lower, taking big losses before finally exiting, and watched Grupo Prisa eventually go to zero.

On the short side, I trimmed my 1.5% position in electric car maker Tesla (TSLA) as it rocketed upward, but I wasn't fast enough. I had shorted it around $35 a share in early 2013 and didn't throw in the towel until after it had soared to $205 a share a year later. It cost me $5 million and was the most expensive mistake of my career. This underscores how critical it is to use stop losses on the short side.

I sold finance giants Citigroup (C) and Goldman Sachs (GS), and tech giant Microsoft (MSFT) far too early, watching their shares march higher for years to come.

But the biggest portfolio-management mistake of my life was, ironically, in one of my biggest winners... I trimmed and then sold my position in streaming company Netflix (NFLX) far, far too early. It's so painful to know that had I only done one thing – held the stock of the decade, which I nailed at the absolute bottom – it would have made up for all of my other mistakes... and then some.

Instead, I took some profits when it went up 50%. When it doubled, I trimmed some more. I kept trimming as it went higher and higher, always keeping it a 3% to 5% position. By the time I sold my last shares, it was up 600% from its lows.

I was so proud of myself for this super-successful investment...

But then the stock rose an additional 600% from where I exited. I left millions of dollars on the table by being too quick to take profits, focusing more on the rising stock price rather than how well the business was doing... It's a mistake that still haunts me to this day.

If there's one portfolio-management lesson I want to leave you with, it's this...

You must let your winners run.

In an investing lifetime, you'll only have a few opportunities to own moonshots like this. Identifying them and then maximizing the profits can make up for a lot of mistakes.

Regards,

Whitney Tilson

Editor's note: If you're like many investors, you likely made some of these mistakes and lost money during the recent crash. But now, Whitney believes you're in a position to recover some of those losses... simply by buying into the right stocks at the right time.

Whitney explained all the details during the "Recovery Investing Event" last week, including what he believes will happen next in the markets... the perfect time to buy into the world's most popular stocks... and what to buy today. Watch a FREE replay of the event right here.