It is difficult to be happy and easy to be sad. If you don’t believe me, then try being happy when you do not invest in the stock market and it goes up; or when you invest in the stock markets and the markets go down. Money is a very strange thing. Human beings make rational decisions while dealing with most aspects of life but make serious errors of judgement when it comes to dealing with money—be it saving, investing, borrowing or spending. Probably none of these errors is as glaring as those that pertain to investment in equities.
Completely rational investors take totally irrational decisions when they are part of a crowd—their own individual rational minds come down many levels—to the irrational level of the crowd. Many a times, rational intelligent persons commit simple mistakes while making investment decisions in common stocks. And the market has its own method of finding and exploiting human weaknesses. I will explain the 10 most common mistakes that investors commit while investing in common stocks.
Mistake 1: Trying To Catch the Top and Bottom
This is one of the most common mistakes—trying to catch the top and the bottom, little realising that only fools or liars can catch the top or the bottom. No one knows what will be the exact top or bottom of any stock; then how does a common investor get to believe that he/she will be able to catch the top or bottom? Instead of that, investors should determine the value and target price of any stock in which they intend to invest by whatever method they follow—fundamental, technical or any other—and then buy it within 5% to 10% range of that ‘buy price’. Remember, if you wait too long to buy, until every uncertainty is removed and every doubt is lifted at the bottom of a market cycle, you may keep waiting and waiting. The same rule will apply while selling.
Mistake 2: It Will Come Back Up
This is another common mistake which most investors commit—whether on the buying or the selling side. If they see a certain price for a certain stock and they miss buying/selling at that price, they keep waiting for that price to come back, irrespective of market or individual stock considerations. The lesson is: If the price of the stock has gone up/down for a change in the prospects of that company or sector, there is no point harbouring the illusion that the ‘price will come back’.
Mistake 3: Already Fallen So Much—Can’t Fall Further
This is another serious mistake. A stock might have fallen ‘considerably’; hence, they believe that it cannot fall further. Nothing can be farther from the truth; this is one of the grave mistakes which results in multiplication of investor losses. Unless the stock becomes attractive on a stand-alone basis on fundamentals or technical or whatever analysis you may believe in, there is simply no logic in believing that “because it has already fallen so much, therefore, it can’t fall further.”
Mistake 4: Already Risen So Much—Can’t Rise Further
This is the opposite of mistake number 3. Often, investors believe that, since the stock has risen so much, it cannot rise further. Unless the stock becomes expensive on valuation basis/future growth expectations basis or any other ‘price determination’ parameter which you might be successfully applying, simply because the stock has risen so much does not make it a sufficient reason to sell.
Mistake 5: Protect Your Profits or Cut Your Losses
Many readers might not agree with me on this point. Unless you are a short-term trader or investing on costly leveraged funds, there is no point in simply trying to ‘protect the profits’ or ‘cut losses’. Unless the stock becomes costly on valuation basis or its fundamentals deteriorate on a long-term basis or because of some other ‘price determination’ parameter which you might be using, just because a stock on which you are making money corrects, it should not make you panic and sell out to ‘protect your profits’.
The same principle would apply for cutting losses; you might be cutting your losses just before the stock is on the verge of embarking on its dream run. On the fallacy of ‘cutting your losses’, the stock might be liquidated just before it might be getting ready for its next dream run which should ideally lead to substantial price appreciation over the medium to long term. Hence, remember that, after doing your analysis, if you feel that the price is right for selling only then sell the stock and not on the misleading notion of protecting your profits because, in fact, by doing that, you might be cutting any probability of serious wealth creation in the future. The same would apply to ‘cut your losses’ fallacy also.
Mistake 6: Price Averaging
This is another grave mistake investors make which takes them deeper and deeper down the loss lane. There is a wrong notion that averaging brings down the purchase cost and, hence, you would be able to sell it at a marginal profit or at least closer to its cost price. One caveat: sometimes, an investor might get an opportunity to exit in the averaged stock at close to the ‘average cost’ but those opportunities are rare and only for a short period. Therefore it is very difficult to capitalise at that point of time. And, finally, if you would not otherwise want to buy a particular stock at a particular price, then what is the logic for averaging it, if you already own that stock? Remember; never throw good money after bad money. If you have made a mistake in selecting a wrong stock, humbly accept your mistake, sell it and book your loss and move ahead. Utilise the proceeds from the sale to buy better investments that have a potential of price appreciation in future.
Mistake 7: Attributing Market Action to Individual Action
Ego and lack of self-confidence are negative qualities of both, a human being and an investor. If you buy a stock and it goes up for no real reason but for market abnormalities, then be smart enough to sell it and get out of it instead of pampering your ego that you are an astute investor or a great stock-picker. Don’t forget that the market is a great deflator of egos. The same can be true when you might have invested in a stock at a decent price after all your analysis and the stock falls for no deterioration in the company’s performance but for some uncontrollable market reasons. Don’t lose self-confidence and start believing that you are wrong. Remember; market can be wrong and is in fact wrong most of the times. So try to take advantage of it abnormalities by using your knowledge, experience and judgement instead of getting swayed by it and losing your self-confidence.
Mistake 8: Efficient Market Theory
Don’t blindly believe in the efficient market theory—in fact remember that market is inefficient for almost 95% of the time. Like a pendulum’s movement from one side (over-valuation) to the other side (under-valuation), it is just by chance that it passes through the middle (fair valuation). If the market were, indeed, always efficient, it would simply be impossible for so many investment gurus and fund managers to claim that they can beat the market. Having said that, over the long term, the pendulum does move in the direction of what is right—if the country, economy, sector and the individual stock does perform well, then, over the longer term, the pendulum does put its weight behind it, otherwise not.
Mistake 9: Blindly Follow the Guru
Either you completely trust your judgement or the judgement of another person. And the other person in the market may be the investment guru or fund managers, etc. Kindly note that you may trust any investment guru of your choice and some investor gurus will beat the market at certain points of time, but all the investor gurus cannot beat the whole market on a continuous basis. Simply put, everybody can’t beat everybody—for there to be a winner, there has to be a loser also. And please note, the buyer and seller are always on the opposite side of the trade and both, mysteriously, believe that they are right. But one of them is wrong! So don’t trust any of the so-called gurus or take them at face value.
Mistake 10: Buying Penny Stocks
This is another common mistake of the investors—buying into penny stocks thinking that the price is already ‘so low’, most probably in single-digit, little realising their own folly. The amount of loss which can happen in common stock investing is reported in percentage terms and measured in rupee terms, whether it be a penny stock of Re1 or a high-priced stock of Rs1,000. Therefore, if a Re1 stock falls to 10 paise or a Rs1,000 stock falls to Rs100, the loss is 90%. And, most importantly, if you invest, say, Rs1,000 in either of the above-mentioned stocks and suppose both of them become zero, you lose your full investment of Rs1,000, irrespective of the initial price of the stock.
So, remember the old saying “penny-wise, pound-foolish”; the stock price is just a quote in the market and, on its own, does not have any significance whatsoever. It has to be measured in conjunction with the company’s performance, earnings, book value, dividends, etc. A high-priced stock may actually be cheap on a valuation basis, while a low-priced penny stock may actually be very costly, if the underlying business does not support even that price.
To conclude, there are many simple and avoidable mistakes which investors commit while investing in common stocks. I have tried to explain some of the most common ones. Kindly note that simple, logical things work far better in the marketplace rather than complex algorithms, theorems, valuations principles, DCF (discounted cash flows), etc. And there is no other place to test your virtues than the market—be it common sense, logical thinking, patience, perseverance, mental balance, emotional intelligence, performing under stress, etc. All the qualities which make a successful human being will be tested by the market –it has its own method of finding and exploiting human weaknesses.
Why fight with the market and try to conquer the stock prices? He, who masters himself, through himself, will obtain true happiness and ultimate success in the stock markets.
Investing is not about beating the market or anybody else, it’s simply beating your own self, your own negative traits. Once you are able to master your own self and become a complete human being, only then would you also become a successful investor. Avoid the common mistakes while investing in common stocks and embark on becoming a successful investor and a complete human being. All the very best!
