11 Errors That Could Cost the Investor a Fortune
By SmartProInvesting.com Stock Investing Team.
February 20, 2008
While investing is done with the principal objective of seeking financial success, it’s not always possible for investors realise the full potential of their investment effort. Though market fortunes can adversely affect the performance, the underachievement is, in many instances, traceable to errors on the part of the investor that limit success. Investors sometimes lose money and at other times watch opportunities slip through. With stock investing, there are many investor actions that could undermine the results that are achieved. Here is a checklist of major investor errors which you should strive to overcome in your quest for investment success.
1. Thinking that Cheap is Hip
Smart investors often look for value in stocks and labour hard to find stocks that are substantially under-priced. That value, however, is not synonymous with being a low-priced stock. A low-priced stock is not necessarily a good bargain and must be judged on its merit. That a stock has crashed to 40% of its high does not guarantee that it will rise any time soon or ever at all. It could well be a dead horse. Much as low-priced (or penny stocks) could provide an investment opportunity when growth prospects are real, burying money in every cheap stock may just mean throwing some hard-earned money down the drain. You must evaluate a company and feel confident that it is worth more than current value and has growth potentials, to be charmed by it.
2. Using Margin Without Due Care
Using margin finance to support your stock trading could be a leverage to more success, but without due care, it could land you in financial trouble. Margin finance is when you borrow, say from a bank, to augment funds for stock investment. That’s particularly risky for public offers in our current circumstances. Considering that the interest rate structure still weighs heavily in favour of the lending financial institutions and not the borrower, your calculations must be right for this to work for you. Particularly when fresh share offers are involved, there are many uncontrollable variables that can throw your computations out of gear. How long the allotment process takes, for instance. Or what proportion of your application will be allotted to you. If you provide a contribution of N5m to borrow N10m to invest in a public offer that takes 5 months to conclude and you receive only 50% of the application, the interest burden is enough to drag you into a financial crises.
3. Not Working to Understand the Market
Every investor doesn’t have to be an investment guru, but whoever stakes money in the market needs to keep learning and trying to understand how it works. Yet many investors are simply looking for shortlist of stocks to buy or sell. That way, they want to depend exclusively on what somebody else thinks, when it’s their money that is at stake. Much as you can benefit from the ideas of some ‘expert’, you are sure to be more careful in any decision-making that involves your money than somebody else. The more you understand the market and can weigh in on the decision process, the better. Reading and enquiring are good ways of boosting that knowledge.
4. Not Cultivating a Personal Investment Strategy
All investors are not the same and each investor needs to understand himself and evolve a strategy that suits his psychology. We can’t all be buying the same stocks, for instance. An investor may be happy to actively trade his stocks and be happy with thin spreads which he hopes will cumulate to a sizeable gain over time. Another investor may just be comfortable with locking into attractive companies and waiting out their performance. Both investors may achieve excellent results through evolving and mastering their chosen strategies. When you have none and try to do everything everybody is doing, your decisions are likely to fail to achieve optimal results and you could loss money to actions you don't understand their basis. Decide a strategy that fits your orientation, try to master it and put it to good use for your ultimate success.
5. Failing to Evolve An Exit Strategy for Gains
Getting into a stock is one challenge, but having a ready strategy for exiting that helps you avoid or minimize loss, while optimizing gains, is another critical success factor. If your stock is doing well and driving up, when do you judge that it’s time to cut it and crystallise your gain? Often, the temptation is to wait to maximize gains, but that’s where the danger of waiting too long also lies. If you don’t develop a guide that you can stick to which brings some discipline into your decision-making, you could experience many regrets. That’s because you are likely to fail to take action at the right time and will only realise there has been another mistake when the market has moved against you. Missed opportunities will not increase your wealth. Unrealised profits can often vanish. If you work with your own rules and take your profit when the set conditions are met, it’s easier to live with, even if the price gain goes any further. Not knowing what you want to do is not helpful and a good way out is to define your rules.
6. Not Deciding How to Manage Losing Stocks
Mistakes are a part of the process and some stocks you choose may fail to fly. When your stock begins to head down in price, dealing with the situation could be confusing. Sell and incur a loss as well as transaction costs and the stock reverses tomorrow? Wait and find that it continues to go down and in an extreme case till much of your investment is gone? Tough decisions and often the investor’s sentiment forces him into errors in decision-making. Here again, you can help the process by setting the rules to guide your actions. That clinical approach will seek to minimize your loss in any situation. Remember that protection of your capital is the first objective. Not achieving good earnings is bad enough, but losing your principal to boot, is a more damaging experience. At what maximum level of loss do you want to cut it and save your principal? Decide your rules ahead of time for a more disciplined, success-driven process.
7. Failing to Understand Market Risk
Every investment entails some risk and the stock market has its dose of it. The price volatility of the stock market is what is often dreaded, but that’s where its profitability also lies. Understanding risk and learning to mitigate it will provide you the courage to engage the market and profit from it, whatever direction it moves. Staying scarred will not permit positive action and that will mean loss of opportunities. Not preparing for the risk will possibly expose your flanks, meaning another possibility of loss. You need to first condition your mind to accept some risk for the potential to profit from the market and then take steps to protect your investment. That is when you will stand a chance to reap from the market.
8. Not Seeing the Opportunity in a Declining Market
Investors are happier that prices continue to drive up. Everybody will keep making money is such market scenario. Yet, that’s not the reality of any stock market. Prices do go down and that often means painful losses for some investors. That’s why a downward sliding market throws up jitters and gets investors scampering for safety, shunning the market. A declining market will however provide a buying opportunity at some point, which discerning investors key into for future profit. To improve your chance of success, you need to learn to manage such market situations more constructively, to profit from them. A downward market is part of the money-making equation of stock investing.
9. Thinking that Frequent Trading Necessarily Means more Earnings
It’s easy to think that if you keep actively buying and selling, churning your stocks around all the time over bits of margins, you make more money. You may be disappointed that it may not be that profitable. You could in fact simply be feeding your stockbroker fat, as you have to incur transaction charges as you buy and sell, often eating deep into the little margin you are aiming for. Trading on an active basis requires close tracking of the market and the investor who wants to do so must be equipped for it. Otherwise, a fairly passive approach may well be more beneficial.
That doesn't say you should lock in and go to sleep. Just that buy and sell decisions must be justified.
10. Not Betting Big Enough
Because of the risks involved, investors often want to play safe and minimize their exposure. The downside is that, when their reading of the market is right and the stocks move as projected, the impact is limited. Yes, the corollary is that when results don’t turn out nicely, the loss is minimised, but what's wrong with a big bang? Anyway, if you are staking big it forces you to do more work. And being decisive is certainly going to be helpful if you desire to achieve significant milestones. If you have done your homework and are convinced you need to take a position in a stock, shouldn’t it be such as should make a difference?
11. Not Exercising the patience that Investment Calls for
Granted you don't want to wait a lifetime to see results, it's very important to understand that the stock market is also not a gaming machine to just draw and hit the jackpot. Even such machines need patience as they are not always turning out such huge winners. Investments demand even more. Your investment, in more cases than not, will yield good results with time. Not being patient to see that through may lead to hasty actions that rob you of your benefit. When you invest, it's good to be reasonable with the time horizon you allocate to your investment to see how it performs.
Getting to improve your strategy in the areas identified here is sure to raise, not just the rigour of your investing process, but its chance of yielding results that bring a substantial difference to your life. What to do? Examine your approach to the market and consider where there is good room to work up your system. Aim to keep refining your process, knowing that when you get things working well, a few good strikes could be all you need to have a better life.
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