With easy access to financial information, hundreds of financial influencers and low-cost online stock trading platforms, it has become easier than ever for people to become stock market participants. More and more people, especially young people who have just started earning, are drawn towards stock market investing either out of unreasonable greed, or for realistic investment opportunities.
Either way, with so many new market participants, it is obvious that they will also make a lot of mistakes. Some of these mistakes are easy to avoid while some others are best avoided lest you wish to lose a lot of your hard-earned money.
For the benefit of market participants, both old and new, I have listed some of the most common and money-destroying mistakes people make when they begin investing in the stock market. As they say, before you learn what to do, learn what not to do. I hope this saves the hard-earned money of investors. I also hope this stops them from being scared away from investing because of the early mistakes that they may have made.
1. Thinking stock market is a casino:
Sometimes, it may work. Even in gambling, people often win in the beginning. But then they begin to lose and never recover. Stock market is not a casino and investing is not gambling. Yes, there is always some uncertainty in all analyses be it fundamental or technical (Learn the difference between the two here) because no one can accurately predict the future. But that does not reduce investing to gambling. Investing in the stock market is not, and doesn’t have to be, an “All or nothing” situation. If you do think so, remember that the odds will always be against you.
2. Thinking that low price stocks are cheap:
Even the sentence above sounds wrong, doesn’t it? “If stock A costs $5 and stock B costs $10, of course, stock A is cheaper”, you’d say. It may be, but that is not the rule. Let me explain
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Say, stock A belongs to company A with total equity, or net worth, of $100, and company B belongs to company B with a net worth of $50. With a $5 stock of company A, you have bought 5% of the company A but with a $10 stock of company B, you bought 20% of company B. So which stock is cheaper now?
A similar case can be made using the revenue or profits of both companies (where the famous P/E ratio comes into picture). Either way, absolute price of a stock does not really mean anything. You may buy a $1 stock which can be “expensive” compared to a $100 stock. What really matters is how much part of a company you buy with a stock, not the absolute price of the stock itself.
3. Not knowing why you bought a stock:
Of all the things you can do in the stock market, this might be the worst. Before you buy a stock, you must know why you bought it. Did you buy it because the underlying company has the potential to grow tremendously in the future? Or did you buy it because it pays dividends? Or was it because the stock price was rising everyday and you just wished to ride the wave?
None of these reasons are better or worse than the others. Eventually, all market participants wish to grow their money in the stock market. You can use any of the hundreds of techniques and analyses available out there to achieve that goal. Fundamental or technical or a combination of both, or just because you like the company's name, whatever be your reason, know it. Because the only way you can make money in the stock market is by knowing why you bought a stock and selling it at the right time…which brings me to the next big mistake.
4. Not knowing when to sell:
Have you ever bought a stock that rose for the first few days or weeks after you bought it and watched with a wet tongue as it “shot to the moon.” Even though you were making much more than you expected, your greed got the better of you and you did not sell it.
Before you knew, it began to fall but you thought, “Of course, it will come right back up pretty soon” but it didn’t and not long after, you realized the fall had wiped out all your profits and you were actually going in loss?
Often, even the initial rise is not afforded to many and the stock just plummets from the moment you buy it. But you still don’t sell. You hold onto it hoping it will come back up as the red before you keeps on increasing until there is nothing left but to forget your money. And often, people who bought the stock only for a short trade end up being "long term investors" in the company, without knowing its A from its B.
If you don’t know why you bought the stock, you will also not know when to sell. Knowing when to sell is actually more important than buying because selling is where you actually make the money . Sell when you think something has changed in comparison to your analysis. If you bought it because the company is good fundamentally, don’t sell as long as that analysis remains true. But if you bought it only to ride the trend, sell it as soon as the trend changes. Don’t hold onto it because the company is fundamentally good because that wasn’t your reason for buying in the first place.
5. Buying on tips:
If you have ever searched “Top 5 companies to invest in”, you were looking for tips. If you ever clicked on a thumbnail that said “Best 10 companies you can invest in blindly”, you were looking for tips. If you ever asked your friends what he is investing in, you were looking for tips.
There is nothing wrong in seeking out new opportunities to invest in but If you put your hard-earned money in companies or investments only because someone “trustworthy” advised you to without knowing anything about the stock or company yourself, you are essentially gambling.
Ask others but do not make decisions solely on tips. Don’t buy because your favourite analyst on TV said so. Buy because you know why and what you are buying.
6. Focusing on individual stocks rather than portfolio:
Often, people find themselves worrying about a couple of stocks in their portfolio. They get ecstatic when one of their many stocks rises substantially, and often they are sad because one of their stocks has failed to give them returns. However, they often fail to focus on what matters the most- their overall portfolio.
It is extremely important to consider ALL the money you have while judging your success or failure in your investment journey. A few lone successes or failures don't matter. Focus on growing ALL your money. Don't miss the forest for the trees.
7. Buying too many stocks:
A mistake I have personally made is buying a lot of stocks…too many. You’d think this is helpful for early investors since the risk gets divided and distributed, essentially negating the risk of losing much even if you are 100% wrong in your analysis, and it’s true. But this approach also comes with 2 major problems:
a) For the same reasons your risk is reduced, your upside is divided too. Owning too many stocks means you will not have substantial quantity of money in any of them. So, if you do manage to find that 100x stock, only a very small amount of your total money grows by 100x while the others lag behind. This means your total returns might still be significantly lesser.
b) If you own too many stocks, you will lose track of them all very, very easily. The lesser stocks you own, the easier it is to monitor. But if you own 100 or 200 stocks, you may not even notice when the trend of one has worsened, or when one of the companies turned bad, and you will lose the potential of tremendous profits by holding onto stocks you should’ve sold.
So, own not too many, nor too few. But just enough.
8. Being afraid of losses:
Losses are a part of stock market, almost as inseparable as oxygen from air. You just cannot function in the stock market without facing losses at some point or the other. But people are often worried about that tiny figure in red, and they hold onto those stocks for eternity, with only blind hope with them. But if you are not able to accept small losses early on, you will definitely run the risk of losing a lot in the future. Don’t be afraid to lose money. Your goal should be to lose as little as possible.
9. Cutting the flowers and watering the weeds:
If someone did this in your backyard garden, you’d get extremely angry. But this Is what people mostly do in the stock market. They cut the flowers and water the weeds i.e., they sell stocks which are rising and hold onto stocks that are in deep red. This is related to the 8th point. Because people just cannot digest the fact that they can be wrong and they have to lose some money.
Selling winners and keeping losers help people convince themselves that they are not losing money. But, in fact, they are most definitely losing, in two ways:
a. By selling rising stocks too early, they risk losing onto a lot of profits that they might have earned if they were a little patient
b. By holding onto losers, they risk losing a lot more money than if they had just sold it earlier when the signals were clearly changing.
Eventually, they end up making a garden of weeds with no flowers in them. And who would like that ugly garden?
10. Falling in love with the company:
Everyone who’s started investing must have a few companies that they rave about to everyone. The love is even more intense if the stock price rises after they invested in the company. But every company faces bad times and downturns. If you love your company so much that you don’t notice your profits are at risk of being wiped out and you hold onto it even when the stock or the company is turning negative, fundamentally or technically, you risk losing.
It is important to not get attached to the companies. As a participant of the stock market, the most important thing is to make money. It doesn’t matter which company or stock you use to achieve that goal.
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