Stock market went down to rock bottom last October, banks and insurance companies failed, investors lose huge amount of money, and followed by raise of unemployment rate. Government gave out hundreds billions dollar tax payers’ money in the form of bailout just to keep the economy afloat. More than a year later, economy is almost back to positive, from the look of it. However, one must not deny it is getting more risky to get into the market nowadays, consider the stock market has rallied beyond the economy fundamental (In my opinion) when unemployment rate is still high and many companies are still losing money. Any negative news will send the stock market into a major correction. As stock investor, it is important for us to learn what are the major mistakes we could possibly make thus to avoid it.
- Lack of financial literacy – One of the major reason why people lose money investing in stock market is because lack of financial education. In order to invest in stock market, one must understand and know how to read financial statements of the company that you are investing in. Three financial statements that we need to understand when come to analyzing a company’s financial position: balance sheet, income statement and cash flow statement. Besides it is very important to understand stock and financial jargons before we can even start looking at stock market. Take one example: Stock ABC and DEF are both selling at $5 and $50 respectively. Which stock is more expensive? A person without any financial knowledge will think $50 is more expensive because the amount is larger. However a person with financial education would understand it takes the underlying company asset and financial prospect to evaluation the true value of the stock. In our example let say ABC cost $5 where by it should have worth $1, and DEF cost $50, where by it is really worth $100. Now which one is more expensive? Obviously stock ABC is 400% more expensive than it should be.
- Follow other people’s idea – Many people without financial education of stock will turn to other sources such stock analysis column in newspaper. Stock analysis is a good reference material for beginner stock investors but it shouldn’t be treated as investment decision. The reason why people can’t make money from buying stock analysis idea is because most analysis reports simply come out too late, before the analysis report being published, professional investors has already gone in and wait to make the killing. Small investors who buy into the stock idea will later go in and immediately get killed by well-informed investors.
- Buying Hot Tips – A lot of time in stock investing arena we heard about so called hot tips from insiders. No people know exactly how true is the tips until proven otherwise. This is when people make a lot of losses by plunging into the stock. Thing is, most of the hot tips is spread from insider just so to push up the stock price so some one also from “inside” can make a profit. This kind of rise is not sustainable in long term, and it will retrace as soon as the news died down or some one has made a handsome profit by selling off the stock.
- Emotional Investor – Admittedly when comes to investing our own money, there is a part in us will always react irrationally, this is our emotion. The fear of losing money. The greed when seeing other investors making money. For those who fears, it usually happens when the person have previously experienced heavy loss from stock investing. The painful experience of losing money will cause him to back away from buying opportunities even though it is good time to buy. Fear will cause investors to stand at the side line, wait and see, and these investors will wait and see as long as they are afraid, but it is only when their fear overwhelmed by greed then they went into the market. They eventually get slaughtered because it is too late when they go in. Wait until fear overcame by greed is too late. There is one saying by the world wealthiest stock investor Warren Buffet: When everyone is afraid, you should be greedy. But when everyone is greedy, you should be very afraid.
- Sell Too Early and Sell Too Late – The first one will not earn you much money, and second one will lose you lots of money. Many people invest in stock without a clear set of exit strategies, strategies define when to sell to lock in to profit and when to sell to cut loss. Many people will sell their stock way too early and then witness the stock price skyrockets afterward. Even more people will hold on tight to the stock as long as the stock is going down, then sell only before it hits zero. Actually, these behaviors can also be attributed from lack of financial intelligence, the skill required to determine the stock intrinsic value thus developing the exit strategy.
- Timing the Market - Some investors believe in prediction, they believe there are signs to look out for the next big stock market movement but many times they are wrong. They make huge loss from believing the so called prophecy. The thing is, stock market is consist of hundreds of millions of institutional, professional and individual investors who act and behave differently that contributed to the erratic and irrational stock movements over time. No one in their limited humanly mind can precisely predict what is going on next.
- Over Diversified – Certain level of diversification is good thing, as it could reduce losses when you are wrong but at the same time it also limit the profit when you are right. Over diversified will most probably kill you. Imagine having to keep track of 10 to 20 stocks per day. Besides, there is a thing call minimum brokerage fee that you need to pay for every stock trade. Since the proportion of each stock investment is small, minimum brokerage fee incurred will drown your potential return so much even before you make profit and try imagining most of the stocks remain status quo. As our greatest stock investor Warren Buffet says diversification is for birds. One diversifies only when he doesn’t know what he is doing.
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