THE 10 MOST COMMON MISTAKES MADE BY INVESTORS (AND HOW TO AVOID THEM!)
The stock market has made countless millionaires and even a lot of billionaires! So why do so many people lose their money on the stock market? Fortunately, the answer is pretty straightforward. Even more fortunately, I've listed the 10 reasons why below:
1) FOMO (FEAR OF MISSING OUT)
FOMO commonly happens when traders sell their positions in underperforming stocks to buy shares in companies that have been moving upwards because they're worried about missing out on further gains. The problem with investing in these momentum stocks though is that they're often close to topping out (reaching their maximum potential) so, when investors begin taking profits, the stock price can begin to fall rapidly and leave latecomers with deep losses.
To add insult to injury, those investors who just took profits in the momentum stocks often rotate out of these now overpriced companies and into the sectors or industries that appear to be forgotten which may well include the stocks that you sold in order to chase the momentum.
How to avoid this: Don't be scared to go against the consensus and consider being greedy when others are fearful by purchasing shares in unloved stocks.
2) NOT FULLY UNDERSTANDING STOCKS
On the stock market, it's common to see many people buying stocks just because other people are buying them too. This rarely ends well though as the key to successful investing is to make a decision about which stocks to buy and stick to it! This is hard to achieve when you're unsure why you own some of the stocks in your portfolio and it's likely that, if you're not confident in a stock, that you'll panic and sell your shares if its price begins to fall for a lower price than you originally paid.
How to avoid this: Create a checklist outlining what you want to look for in an investment. Be sure to run each stock through this checklist before buying it to ensure that you understand why you're purchasing shares in this company.
(Click HERE to check out the 10 signs of a great stock that I look for)
3) OVER TRADING
The vast majority of successful investors will tell you that the best way to invest in the stock market is to have a long term strategy. Many investors however still frequently buy and sell stocks based on short term price fluctuations or things that they have heard in the media. In my opinion, by keeping your trading frequency to a minimum you will reduce your chance of falling victim to FOMO and momentum trading whilst also ensuring that you don't rack up unnecessary trading fees!
How to avoid this: Remember that anything can happen to stocks in the short term but over long periods of time, successful businesses will almost certainly be worth a lot more than they are now.
4) LACK OF SPECIALISATION
Warren Buffett, the world's most successful investor, has one strategy: Buy and hold shares in undervalued companies. He would consider a business undervalued if it has a strong management team, a competitive advantage and is trading at a discount to industry peers. Although remaining in his comfort zone has meant that Buffet has missed out on some incredibly lucrative investments, his trading success shows that sticking to what you know pays off!
How to avoid this: When it comes to picking stocks, choose an area of competence to specialise in and stick with this.
5) EMOTIONAL TRADING
Often the precursor to over trading, emotional trading is when investors make trading decisions based on their emotions or fear of losing money. Unfortunately, this type of trading is a key reason why investors may end up selling and buying stocks at the wrong times often becoming the victim of panic selling or FOMO.
How to avoid this: Don't invest more than you can afford. This will decrease the chance that you'll panic and start emotional trading during market turbulence.
6) SELLING WINNERS TOO SOON
In the trading world, we often hear the advice "Cut your losses and let your winners run." Unfortunately though, this is easier said than done and we can often end up doing what's known as the disposition effect (where traders sell their winning trades far too early to lock in profits but hold onto losing trades in an effort to avoid accepting a loss). This tendency causes traders to perform poorly and unfortunately, many of us have experienced this far too often.
How to avoid this: Remember that if you do your research and find an innovative business at the centre of a growing industrial trend then 500% gains are easily possible. Don't sell just because you have made a 25% profit, reevaluate the stock and if it still seems cheap then stick with it!
7) IGNORING THE CHARTS
I'm not saying that you need to buy stocks based purely on statistical analysis but try to have an occasional glance at the charts because many investors do and will buy and sell based on certain indicators including support, resistance levels and moving averages. By knowing these important points on the charts you can further identify stocks with greater opportunity or risk. Also, the more investors that use statistical analysis, the higher the likelihood that these chart patterns will occur.
To avoid this: Try to ensure that you're identifying business with long term potential and look at the chart patterns to find the right time to purchase a stock whilst ensuring a margin of safety (less risk).
8) NOT PROPERLY DIVERSIFYING
When investing in the stock market it's important to have a risk management plan and one of the best ways to achieve this is by ensuring that your investment portfolio is properly diversified. Although it's possible to over diversify, it's more risky to under diversify so try to include a variety of different stocks in your portfolio to limit your losses and reduce wild fluctuations.
How to avoid this: Try not to have more than 10% of your portfolio in an individual stock and try to hold a number of stocks across a couple of different sectors to better protect yourself from disruption.
9) OVER COMPLICATING
Yes the stock market can be complicated, especially if you try to buy and sell stocks regularly to keep up with short term movements in the market. However, if you utilise the stock market as a long term investor, it can be remarkably simple. Just identify long term growth or irreplaceable industries and then invest in well run businesses that have a clear competitive advantage within that space. Leave your investments for a couple of years at the least and only consider selling if something has fundamentally changed the prospects of the companies that you've invested in.
How to avoid this: Remember “Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell.” Warren Buffett.
10) DWELLING ON MISTAKES
We all make mistakes and it may be that we've fallen victim to one of these points already. This happens to most investors though and, as with anything, it's important to learn from your mistakes rather than dwelling to ensure that you limit the possibility of it happening again in the future.
How to avoid this: If you sold your shares in a company to lock in some profits yet the stock price continues to climb higher, try removing it from your watchlist and forgetting about it for now. Stop worrying about getting back into that trade and concentrate on finding another stock that presents an even better opportunity.
If you can avoid making these common mistakes then you will likely save yourself a lot of hassle and a lot of money! Don't feel bad when you do slip up though! Mistakes are inevitable in all walks of life and every investor will make many but the faster you learn, the better!
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