Money is a very
strange thing–human beings make rational decisions while dealing with most
aspects of life but make serious errors of judgment when it comes to dealing
with money – be it saving, investing, borrowing or spending – and probably none
are so glaring then when it comes to investment in equities. Completely rational
investors take totally irrational decisions when part of crowd – their own
individual rational minds come down many levels to the irrational level of the
crowd. Many a times, individual rational intelligent persons commit simple
mistakes while making investment decisions in common stocks. And market has its
own method of finding and exploiting human weaknesses. I try to explain and
explore the 10 most common mistakes which investors commit while investing in
common stocks.
Mistake 1: Trying to
catch the top and bottom
This is one of the
most common mistake while investing in equities which most of the investors
commit i.e. trying to catch the top and the bottom little realizing that only
fools can catch the top or the bottom. No Government, Central Bank, company
management, fund manager, analyst or anybody knows what will be the exact top or
bottom of any stock, then how does a common investor believe that he / she will
be able to catch the top or bottom. Instead of that, determine the value and
target price of any stock in which you intend to invest by whatever method you
may follow – fundamental, technical or any other method- and then buy it within
5% to 10% range of your that “buy price”. You may pace out the purchase over a
period of time keeping in mind the current performance of that company and / or
the overall market conditions. But, once you determine the “correct price” for a
stock to buy by whatever method you may follow and once that price approaches
then don’t wait to “buy at the bottom” because you will probably never be able
to do that. Remember that 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
also.
Mistake 2: It will
come back
This is another common
mistake which most of the investors commit while investing in equities – whether
on the buying or selling side. If they see a certain price for a certain stock
and they miss buying / selling at that price, then they keep waiting in
anticipation that the same price will come back, irrespective of market or
individual stock considerations. For example, somebody might have decided on
whatever kind of analysis he / she might have done that Unitech is to be sold.
Then he / she saw the price of Rs.530 in January 2008 but “missed” selling at
that price and after that the stock started falling because of general market
weakness and fundamental deterioration in the company. But, the investor who is
influenced by this common mistake and waiting for the “price to come back” might
still be waiting with the current price around Rs.26 and I don’t know whether
the price of Rs.530 will ever come back! The lesson to be learned is that if the
price of the stock has gone up / down for a change in the prospects of that
company or sector, then there is no point being in illusion that the “price will
come back”.
Mistake 3: Already
fallen so much – cant fall further
This is one another
serious mistake which many investors commit while investing in equities. A stock
might have fallen “considerably” and hence they believe that now it cannot fall
further. Nothing can be further from truth as this is one of the grave mistakes
which results in multiplication of investor losses. Continuing with the Unitech
example, the stock fell from Rs.530 in January 2008 to Rs.240 by March 2008,
a massive fall of 45% in just two
months. Now, any investor who might have believed that it cant fall further
because it has fallen 45% in 2 months and hence held on to it / purchased it was
in for a rude shock as it fell to Rs.20 by December 2008, a massive 96% from the
top and also a substantial fall of 92% from the March 2008 level of Rs.240.
Unless the stock becomes attractive on a standalone basis on fundamental or
technical or whatever analysis you may believe in, there is simply no logic in
believing that “because it has already fallen so much and therefore it cant fall
further”.
Mistake 4: Already
risen so much – cant rise further
This is the corollary
of mistake number 3 – many times investors believe that since the stock has
risen so much, hence it cannot rise further. For example, Titan rose from around
Rs.5 in July 2004 to Rs.42 by March 2006, stupendous jump of more than 8 times
in less than 2 years. Anybody, thinking that the stock has risen so much and
therefore cant rise further and sold it was for a rude surprise as the stock
rose to Rs.237 by September 2011, not only swelling by 47 times from its July
2004 price of Rs.5 but even multiplying by around 5.5 times from its march 2006
level of Rs.42. Hence, unless the stock becomes expensive on valuation basis /
future growth expectation basis or any other “price determination” parameter
which you might be successfully applying, simply because the stock has risen so
much does not warrant 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 does not necessitate you to panic and
sell out of it to “protect your profits”. Lets continue with the above example
of Titan. After multiplying by about 8 times from Rs.5 in July 2004 to Rs.42 in
March 2006, the stock corrected to Rs.21 by May 2006, almost halved from its
peak of March 2006 in just two months. Any investor who might have panicked and
sold the stock then would be in for a nasty surprise as the stock then went on
to Rs.85 by December 2007 i.e. 4 times jump from the May 2006 low and beyond
that as we now know it has touched Rs.237 by September 2011. The same principle
would apply for cutting losses as you might be cutting your losses just before
the stock is on the verge of embarking on its dream run. Lets continue with the
Titan example above. Now, suppose you purchased the stock at Rs.42 in March 2006
and it halved to Rs.21 in the subsequent two months and you are nursing a
massive 50% loss. On the fallacy of “cutting your losses” if you sell the stock
at Rs.21 then you have sold it just before it was getting ready for its next
dream run which would lead to many times price multiplication over the next few
years. Hence, remember that after doing your analysis if you feel that the price
is right for selling than only 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 which investors do which takes them deeper and deeper down the loss
lane. There is a wrong notion then averaging brings down the purchase cost and
hence would be able to sell it at some marginal profit or atleast closer to cost
price. Let us move back to the example of Unitech, suppose you invested in 1
share at Rs.530 in January 2008, then “averaged” by buying one more share at
Rs.300 in February 2008 and further averaged by purchasing another one share at
Rs.240 in March 2008 so that now your reduced “average cost” is Rs.357. But,
what purpose has that served, today the stock is quoting around Rs.26, down by a
phenomenal 93% from the reduced “averaged cost”. One caveat, that sometimes an
investor might get an opportunity to ext in the averaged stock at close to the
“average cost” but those opportunities are rare and only for a short period of
time and therefore very difficult to capitalize 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 your
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, - utilize the proceeds from sale to buy better
investments with potential of price appreciation in future.
.
Mistake 7: Stocks gone
up so I am right or gone down so I am wrong – The Market Trap
Ego and lack of self
confidence are both negative qualities of 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 all 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 – during that point of time there is no need to
panic and loose self confidence and start believing that you are wrong. Remember
that market can be wrong and is infact wrong most of the times, so try to take
advantage of it abnormalities by using your knowledge, experience and judgment
instead of getting swayed away by it and loosing your self confidence.
Mistake 8: Efficient
Market Theory
Don’t blindly believe
in the efficient market theory – infact remember that market is inefficient for
almost 95% of the time – its like a pendulum moving from over valuation to under
valuation and then vice versa. Only 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). And if the market was indeed
always efficient it would simply be impossible for so many investment gurus and
fund mangers 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 than over
the longer term the pendulum does put its weight behind it, otherwise not.
Mistake 9: Blindly
follow the Guru
There is a saying that
either you completely trust your judgment or the judgment of another person. And
the another person in the market is 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 in totality beat the whole market on a continuous basis
because they only make up the market. Simply put, everybody cant beat everybody
– for there to be a winner, there has to be a looser also. And kindly note, the
buyer and seller are always on the opposite side of the trade and they both
mysteriously believe that they are right – but one of them is infact wrong! So
don’t trust any of the so called Investment gurus as face value (including myself although I don’t claim to
be any investment guru but just a student of investing).
Mistake 10:
Penny Stocks
This is another common
mistake which most of the investors commit – buying into penny stocks thinking
that the price is already “so low”, most probably in single digit, little
realizing their own thinking 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 Re.1 or a high priced stock of Rs.1000.
Therefore, if a Re.1 stock falls to 10 paise or a Rs.1000 stock falls to Rs.100,
the loss is 90% in both cases. And most importantly, if you invest say Rs.1000
in either of the above mentioned two stocks and both of them suppose become
zero, then you loose your full investment of Rs.1000, 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 valuation basis while a low priced penny stock may
actually be very costly if the underlying business does not support even that
much of a price.
Mistake 11: Fail to past the test of patience and character
Market is a place
which will test your patience and character. Many times you might have bought a
stock for all the right reasons at the right price but the stock refuses to go
up for a long period of time – just hang on to it because the day you get
frustrated and sell it off, there are chances the stock will then start rising.
Hence, patience and character are key virtues which will be repeatedly tested by
the market.
To conclude, there are
many simple and avoidable mistakes which investors commit while investing in
common stocks and I have tried to explain some of the most common ones of them.
Kindly note, that simple logical things work far better in the market place
rather than complex algorithms, theorems, valuations principles, DCF 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. Investing is not about beating the
market or anybody else, its simply beating your own self, your own negative
traits and once you are able to master your own self and become a complete human
being, then only you would 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.
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