• OCTOBER 5, 2010

Are you making these investing mistakes?

We are all investors. That is why we read up on the markets. Accept stock advices. Invest our hard earned money. Track our investments. Go berserk when the investments don't perform. Celebrate when they do perform. The bottom line is we are investors.

So what are the common mistakes that 'we' (investors) as a community make? In this article we'll go through some of the most common investing mistakes and how to avoid them.

  1. Overconfidence: It is in human nature to think of ourselves to be superior to our peers. When we do something and it goes right and this trend continues, we start attributing this to our 'greatness'. Not to our skills. Not to the environment. Most importantly not to the guidance or help that we may have received. We start confusing luck with skill.

    This is one of the biggest mistakes we make while investing as well. If we invest in a stock and the prices go up, we will start thinking that this is a trend. The price will continue to go up. Therefore, we suffer major shocks and potentially major losses, when this trend breaks and the stock price comes crashing down.

    Solution: Valuations. This age old concept can actually bail us out and prevent us from falling into the trap of overconfidence. How does this work? It is simple. When valuations of the stock get stretched, it is time to sell. The stock may go up even after we sell. But, it is important to understand that this will not continue to happen indefinitely. Eventually valuations will start to kick in and the prices will start to fall. Better to be safe than sorry and sell when the valuations get expensive.

  2. Do something, anything: All gurus of value investing talk about the stockmarkets as a mythical creature called Mr. Market. This devious little creature is there to trick investors. The worst part is that he is extremely good at his job and pretends to be an investor's friend. The fact is that Mr. Market wants the investor to do something. Anything as long as it is an action. He will be charming, convincing, scary, intimidating - everything to force you to act. What he does is to force you to buy when the prices are at its peak and to sell when the prices are at its bottom. Common sense can tell us that this is ridiculous business practice. You buy when the prices are low and sell when the prices are high. That is the only way to make money.

    Solution: Mr. Market can hurt us only if we allow him to do so. When he is depressed and scary, he is giving you investment opportunities at great prices. This is the time to buy. When he is exuberant, he is giving you the opportunity to sell your stocks. This is the time to sell. The bottom-line is having patience. The right opportunity will come. We have to understand that investing is like raising 'teenagers'. It is interesting along the way as they grow into fine adults. Experienced parents don't focus on the short term dramas and hiccups. They focus on the long term

  3. Charting and trends: Psychologists have identified a tendency in people that they tend to think that they have control in situations when in fact they have none. This is why many investors turn to charting. They identify "patterns" and "supports" in historical prices to tell them what the future will hold. But the truth is these are patterns of history. Not of the future. The likelihood of history repeating itself in the future is very low. We must understand that charting is like astrology. Only one in a thousand astrologers is correct. This is the same case in charting. There is no dependable way to predict the future movements of a stock's price based on its historical movements.

    Solution: Rely on fundamentals. Fundamentals define the value of the stock that you own. In the long run, the fundamentals will get reflected in the price of the stock. This is the best way to maximize your returns.

  4. Brokers: There is an interesting joke on brokers. "Define a broker - someone who helps you go broke". We know this is not a laughing matter but time and again this definition has unfortunately proved itself to be true. As a professional, the broker is focused on earning money for himself. The only way in which he can do this is by earning a commission fee on the transactions carried out by his clients. By his clients we mean the investors. So to earn his own income, he has to make sure that the investor keeps on carrying out a transaction in the market. This could be selling or buying. Either way a broker, just like Mr. Market, forces his clients to do something in the market. And just like following Mr. Market's advice, this something can actually end up in losses for the investor.

    Solution: Use your own judgment when it comes to investing in stocks. After all it's your money.
We hope having identified the common mistakes, investors would avoid making them. Happy investing!

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