To err is human, and forgive is divine. This becomes very relevant while discussing learnings during investing. The learning process of investing/trading by default encourages making mistakes. Investors are involved in longer-term holdings of stocks and securities. Traders generally buy and sell futures and options, hold those positions for shorter periods, and are involved in a greater number of transactions than an investor.
While traders and investors are acclimatized to different patterns of trading transactions, both leave no void in falling prey to feeling guilty about making the same types of mistakes. Some mistakes aid in realization, some in learning but some prove to be harmful to the investor/trader. Both would be in a better position if they remember these common blunders and try to avoid them.
Common retailer investing blunders
No Trading Plan
What is the very first thing you do after you have made up your mind to start Investing? Watch stock news channels or take suggestions from friends and distant relatives who have invested then finalize some stocks and start right away! You need a stock pick strategy.
If this plan fails, since one is in the market and has consciously discussed a series of stocks, it’s evident that one must have developed a special liking for that stock and begins his investing gig! We are not surprised your portfolio didn’t perform well! So, what do you think, was the news biased?
Did your friends, family members, or a distant relative suggest the wrong stock on purpose? Was your love for choosing the stock not enough, that it started dumping you? What do you think the problem lies in? Or since when did planned stuff start backfiring?
Let us understand everything right from the root causes. The problem is there was no planning at all! Experienced traders get into a trade with a well-defined plan. What do we mean by a plan?
An investor plans his exact entry and exit points, the amount of capital to invest in the trade, and the maximum loss they are willing to bear and has a risk management process in place. Naive/Beginner investors may not have a trading plan in place before they commence trading. Even if a beginner has a plan, sticking to it with discipline is the most challenging task.
They are more prone to get disturbed by day-to-day market volatility than a seasoned investor. For example, Soham bought 100 shares of company X. He very well knows that the market is bullish, and his stock will perform well today – it goes up by 250 points (250 points X 100 shares = Rs 25,000). His Demat account is right now showing a profit of Rs 25,000. Soham is overjoyed.
The next day, due to minor fluctuations, the market corrects itself by 0.5%. Stock X corrects itself by 100 points (-100 points X 100Shares= Rs. 10,000). His Demat account is right now showing a profit of Rs.15,000. (25000-10000= 15000). Soham gets worried and thinks that the market can take a deep dip tomorrow and exits with a profit of Rs 15,000.
The following day he sees that there was a gap-up opening in X, and it was up by 550 points. Had Soham controlled his emotions and designed a proper plan before setting his investing plan he must not have regretted his foolishness. Not to forget the market is still trending. In stock markets, opportunity loss leaves a more significant impact than monetary loss. Therefore, every investor must have a stock portfolio management in place.
Chasing Performance
99% of investors/traders will select asset classes, strategies, managers, and funds based on current strong performance. The feeling that “Oh! If I don’t invest now, I’ll definitely miss out on great returns” has probably led to more bad investment decisions than any other single factor.If a particular asset class, strategy, or fund has done extremely well for three or four years, we know one thing with certainty: We should have invested three or four years ago.
And now, however, the particular cycle that led to this great performance may be nearing its end. The smart money is draining out, and the dumb money is pouring in.
Re-Balancing in regular intervals
Rebalancing is the process of returning your portfolio to its target asset allocation as decided in your investment plan. Rebalancing is strenuous because this process can force an investor to sell the asset class that is performing well and buys more of your worst-performing asset class. This contrarian action is very difficult for many novice investors.
However, a portfolio, well strategically planned for investment and allowed to drift with market returns guarantees that stocks will be overweighted at market peaks and underweighted at market lows, which formula for poor performance. Rebalancing religiously is step by step reaping long-term rewards. If you are not rebalancing your portfolio, opting for investment advisory services can be the right thing.
Ignoring Risk Aversion
Every investor’s Risk-taking ability different. One must not lose sight of risk tolerance or your capacity to take on risk. Some investors can’t digest volatility and the ups and downs associated with the stock market or more speculative trades. Other investors may need secure, regular interest income. These low-risk tolerance investors would be better off investing in the blue-chip stocks of established firms and should stay away from more volatile growth and start-up companies’ shares. Remember that any investment return comes with a risk.
Dog watching the Time Horizon
Don’t invest without a time horizon in mind. There may be a possibility that one might need funds all of a sudden, and hence one must think before locking up into an investment before entering the trade. Also, “determining how long” plays a key role. Other plans like retirement savings, a down payment on a home, or a college education for your child may hinder your plans.
If you are planning to accumulate money to buy a house, that could be more of a medium-term time frame. However, if you are investing to finance a young child’s college education, that is more of a long-term investment. If you are saving for retirement 30 years hence, what the stock market does this year or next shouldn’t be the biggest concern.Once you understand your horizon, you can find investments that match that profile.
Stop-Loss Orders
A big sign that you don’t have a trading plan is not using stop-loss orders. Stop orders come in several varieties and can limit losses due to adverse movement in a stock or the market as a whole. These orders will execute automatically once they are set. Placing stop losses turns advantageous because losses are capped before they become sizable.However, there is a risk that a stop order on long positions may be implemented at levels below those specified should the security suddenly gap lower as happened to many investors during the Flash Crash.
Even with that thought in mind, the benefits of stop orders far outweigh the risk of stopping out at an unplanned price. Another common mistake an investor makes is when he cancels a stop order on a losing trade just before it can be triggered because apart from logic their gut feeling says there could be a trend reversal.
Letting Losses Grow
This is one of the characteristic features of beginner trading. A naïve investor becomes paralyzed if a trade goes against them. Rather than taking quick action to cap a loss, they may hold on to a losing position in the hope that somehow their luck could be played. A losing trade can tie up trading capital for a long time and may result in mounting losses and severe depletion of capital.
For example, Mona purchases 500 shares of Satyam. She bought these stocks when the trend started to elevate. Mona was happy, her stock was doing good and she made a whopping amount of profit. Her target was achieved. However, instead of exiting the stock, he chose to hold on to it for a little while more. The next day she sees some bad news about the company and the stock prices start to fall. Mona devises a new strategy, she feels the stock is good, but this might be a bad day for the company.
She waits for a little longer and thinks to buy 500 more stocks so that in the long run her returns grow speedily. The stock prices further dipped and so did she keep ensuring herself that her strategy is still in place. One fine day the current price of Satyam went below the buy price, not only did Mona lose all her profit but right now she is suffering a capital blow. Stock Market is for all, it is filled with infinite opportunities. Once in a trade grab whatever you have got and go.
Averaging
Averaging down on a long position in stock may work for an investor who has a long investment horizon, but it may look like digging a grave for your portfolio if one is trading volatile market condition or short term. Some of the biggest trading losses in history have occurred because a trader kept adding to a losing position, and was eventually forced to cut the entire position when the magnitude of the loss became unbearable.
Traders also go short more often than conservative investors and tend toward averaging up, because the security is advancing rather than declining. This is an equally risky move that is another common mistake made by a novice trader.
Don’t forget to start again
The worst thing one can do is let pride take priority over one pocketbook and hold on to a losing investment. Or worse yet, buy more shares of the stock as it is much cheaper now. Trust me this is a very very common mistake! This thinking pattern starts with comparing the current share price with the 52-week high of the stock. And then assume that a fallen share price represents a good buy. However, there was a reason behind that drop and price and it is up to you to analyze why the price dropped.It’s time you drop this herd mentality!
Believing in False Buy Signals
It is important to always have a critical eye, as a low share price might be a false buy signal. Avoid buying stocks in the bargain basement. In many instances, there is a strong fundamental reason for a price decline. Do your homework and analyze a stock’s outlook before you invest in it. You want to invest in companies that will experience sustained growth in the future.
Tip: A company’s future operating performance has nothing to do with the price at which you happened to buy its shares.
Buying with Too Much Margin
If you are a novice trader/investor, never ever borrow money and invest.Every stock advisory company will tell you the same based on their experience with thousands of investors and traders.
Invest with your own money, even if the capital is a smaller amount, it is the right way. Margin is using borrowed money from your broker to purchase stocks, this is in the case of usually futures and options. While margin can help you make more money, it can also pull once losses just as much.
Make sure you understand how the margin works and when your broker could require you to sell any positions you hold. The worst thing one can do as a new trader is become carried away with what seems like free money. If you use margin and your investment doesn’t go the way you planned, then you end up with a large debt obligation for nothing.
Ask yourself if you would buy stocks with your credit card. Of course, you wouldn’t. Using margin excessively is essentially the same thing.Further, using margin means monitoring your positions much more closely. Over emphasized gains and losses that accompany small movements in price can turn into a disaster.
If you don’t have the time or knowledge to keep a close eye on and make decisions about your positions, and their values drop then your brokerage firm will sell your stock to recover any losses you have accrued. As a new trader use margin sparingly, if at all; and only if you understand all of its aspects and dangers. It can force you to sell all your positions at the bottom, the point at which you should be in the market for the big turnaround.
Sheep Mentality
Another common trait seen in new traders is that they blindly follow the herd; as such, they may either end up paying too much for hot stocks or may initiate short positions in securities that have already plunged and may be on the verge of turning around. While experienced traders follow the dictum of the “trend is your friend”, they are accustomed to exiting trades when they get too crowded.
New traders, however, may stay in a trade long after the smart money has moved out of it.Novice traders may also lack the confidence to take a contrarian approach when required.
It’s all diversifying folks!
Diversification is a way to avoid overexposure to any one investment. . In a simple sense, it’s avoiding keeping all your eggs in one basket. Having a portfolio made up of multiple investments protects you if one of them loses money. You need stock picks across sectors, market caps, and industries.
It acts as a shield against volatility and extreme price movements in any one investment. Also, when one asset class is underperforming, another asset class may be performing better. Many studies have proved that most managers and mutual funds underperform their benchmarks. Over the long term, low-cost index funds are typically upper second-quartile performers or better than 65%-to-75% of actively managed funds. Despite everything in favour of indexing, the desire to invest with active managers remains strong.
Cheating on Homework
Novice traders/investors are often blameworthy for not doing their homework or not conducting adequate research, or due diligence, before initiating a trade. Doing homework is critical because a beginning trader does not know seasonal trends, the timing of data releases, and the trading patterns that experienced traders possess.
For a new trader, the urgency to make a trade often overwhelms the need for undertaking some research, but this may ultimately result in an expensive experience and lesson. It is a crime not to research an investment that interests you. Research helps you understand a financial instrument and know what you are getting into.
If you are investing in a stock, for instance, research the company and its business plans. Do not act on the premise that markets are efficient and you can’t make money by identifying good investments.
While this is not an easy task, and every other investor has access to the same information as you do, it is possible to identify good investments by doing the research.
Buying Unfounded Tips
No investor escapes this blunder in his/her investing career. Relatives or friends keep talking about a stock that they heard will get bought out, have killer earnings or soon release a groundbreaking new product.
Even if these things are true, they do not necessarily mean that the stock is “the next big thing” and that you should rush into your online brokerage account to place a buy order. Other unfounded tips come from investment professionals on television and social media who often push a specific stock as though it’s a must-buy but is nothing more than the flavor of the day. These stock tips often don’t pan out and go straight down after you buy them. Remember, buying on media tips is often founded on nothing more than a speculative gamble. And when such news flashes, a novice investor think ‘This is a message just meant for me by God, I must accept the sign’, and get trapped. This isn’t to say that you should balk at every stock tip.
If one really grabs your attention, the first thing to do is consider the source. The next thing is to do your homework and ask yourself the necessary analytical questions. For example, buying a tech stock with some proprietary technology should be based on whether it’s the right investment for you, not solely on what a mutual fund manager said in a media interview.
Next time you’re tempted to buy based on a hot tip, don’t do so until you’ve got all the facts and are comfortable with the company. Ideally, obtain a second opinion from other investors or unbiased financial advisors.
Idiot box and Financial advice – Bad combination
There is almost nothing on financial news shows that can help you achieve your goals. Honestly! Few newsletters can provide you with anything of value. Even if there were, how do you identify them in advance?
Think of it, if anyone really had profitable stock tips, trading advice, or a secret formula to make big bucks, would they blab it on TV or sell it to you per month? No, right! They’d keep their mouth shut, make their millions, and not need to sell a newsletter to make a living. Solution?
Spend less time watching financial shows on TV and reading newsletters. Spend more time analyzing, designing, and sticking to your investment plan. It works!
Not Seeing the Big Picture
For a long-term investor, one of the most important but often overlooked things to do is a ‘Qualitative Analysis’. It simply means to look at the big picture! Pouring over financial statements or evaluating buy-sell opportunities with complex technical analysis may work a great deal of the time, but if the world is changing against your company, sooner or later you will lose.
After all, a typewriter company must have outperformed in its industry, but once personal computers started to become commonplace, an investor in typewriters of that era would have done well to assess the bigger picture and pivot away.Assessing a company from a qualitative standpoint is as important as looking at its sales and earnings.
Qualitative analysis is a strategy that is one of the easiest and most effective for evaluating a potential investment.
Overconfidence
Nowadays everyone wants to invest. And hence investing would be evergreen, but the “beginner’s luck” experienced by some novice traders may lead them to believe that trading is the perfect road to quick riches.Such overconfidence is dangerous as it breeds complacency and encourages excessive risk-taking that may culminate in a trading disaster.Trading/Investing is a marathon, not a sprint.
Inexperienced Day Trading
If you insist on becoming an active trader, think twice before day trading. Day trading can be a dangerous game and should be attempted only by the most experienced ones. In addition to investment savvy, a successful day trader may gain an advantage with access to special equipment that is less readily available to the average trader. Did you know that the average day-trading workstation (with software) can cost thousands of lakhs of rupees? One will also need a sizable amount of trading money to maintain an efficient day-trading strategy. The need for speed is the main reason you can’t effectively start day trading
Most investment advisory services recommend that investors take day-trading courses before getting started. Unless you have the expertise, a platform, and access to speedy order execution, think twice before day trading. If you aren’t very good at dealing with risk and stress, there are much better options for an investor who’s looking to build wealth.
Underestimating Your Abilities
Some investors tend to believe that they can never excel at investing because stock market success is reserved for ultra-cosmopolitan investors only. This is not true! With a little time devoted to religious learning and research, investors can become well-equipped to control their own portfolios and investing decisions, all while being profitable. Remember, much of investing is sticking to common sense and rationality.
Besides having the potential to become sufficiently skillful, individual investors do not face the liquidity challenges and overhead costs of large institutional investors. Any small investor with a sound investment strategy has just as good a chance of beating the market, if not better than the so-called investment gurus.
Don’t assume that you are unable to successfully participate in the financial markets simply because you have a day job.If you have the money to invest and are able to avoid these beginner mistakes, you could make your investments pay off; and getting a good return on your investments could take you closer to your financial goals.
Discipline and Patience is the key!
With the stock market’s penchant for producing large gains (and losses), there is no shortage of faulty advice and irrational decision-making.As an individual investor, the best thing you can do to pad your portfolio for the long term is to implement a rational investment strategy that you are comfortable with and willing to stick to.If you need help, don’t hesitate, get one from your fund manager and have faith in your plan.If you are looking to make a big win by betting your money on your gut feelings, this surely sounds great.You must definitely try casino! Take pride in your investment decisions, and in the long run, your portfolio will grow to reflect the soundness of your actions.