RIYADH, 14 February 2005 — Investing mistakes are not much different from other real life mistakes, other than they can be more expensive. Unless we acknowledge and learn from them, we deprive ourselves from a unique opportunity of advancement. Unfortunately basic instinct works in the opposite direction of admitting mistakes. People usually overestimate their knowledge, overlook their mistakes, and accordingly loose a major learning prospect. By eliminating say fifty mistakes from the potential investment mistakes list, we get closer to success with the smaller number of remaining potential mistakes. Edison’s famous quote of discovering hundred wrong ways — mistakes, finally lead him to discover one of the greatest contribution to humanity. Experts recommend that stock market players should take the time to revisit their investment strategies and learn from mistakes on a regular basis. Here are several common mistakes that conscious investors should avoid.
• Trading for Revenge: Remember that the market is bigger and stronger than all of us. It has been around a lot longer than we have and it will still be here long after we are gone. When your ego is bruised because of that trade that went against you for no apparent reason, just remember that if you fall in the dark spiral of trading for revenge, the only thing that you are going to end up doing is to give back your hard earned saving. Avoid falling into this the trap. Take a time out, and play the game on your terms. Instead of fighting the market, read it, follow it and ride it like a wave. Don’t worry, it is not going anywhere, it will still be there tomorrow.
• Buy and hold, but don’t do it blindly: Stocks typically rise over time, but that doesn’t hold true for every stock. Some don’t survive for too long. Different stocks may call for different investment strategies.
• I like the product, so I’ll buy the stock: This is a good start, but you need to have more than a little bit of surface knowledge of the company. By doing research, you’ll find facts that will either confirm or refute your gut instinct on a stock.
• The stock price doesn’t matter if it’s a solid company, since I want to hold it for the long term: Don’t ignore stock’s price. If you buy the stock at a high price and then it drops, it could take years before you’ll get your money back, if ever. Checkout how expensive a stock is by comparing its price-to-earning ratio to the industry’s average and to its rivals. A good stock will be more expensive, but you can find out if the valuation is justified by looking at projected sales and earnings growth.
• I am hanging on to a loosing stock until I break even: The risk is that you may never break even. By refusing to sell a laggard stock, you risk loosing your entire investment. Keep stocks with good prospects. Is it a growing industry? Is the company increasing it’s market share? Are its sales and earnings rising faster than those of competitors? Does it have good management and superior products? If not, don’t be afraid to dump the stock, and try to recoup your money elsewhere. Your decision to keep a stock should be based on its future prospects and not on what you paid for it.
• I can only afford to buy cheap stocks: Some investors think they are getting a deal by buying 1000 shares of $2 stock instead of 100 shares of $20 stock. They reason, if the stock goes up one dollar, then they’ll get a higher return on their money. What they overlook is that the potential loss is similar to that of profit, and accordingly they can loose a big portion of their investment if it goes down by the same amount. In many cases, the stock price is cheap for a reason. The price of a stock is different from its value.
• I feel safe to take such a decision because everyone else is doing the same: We have an innate desire to be part of a crowd and feel safer making mistakes with others than striking out on our own. If you happen to be right when others are wrong, then you can strike a big return on your investment.
• I know that this is right and I will go ahead and do it: We suffer from over confidence in our abilities and should resort to check and balance regularly. Successful investment decisions cannot be based on gut feeling instead a thorough analysis should precede every decision.
(Salim J. Ghalayini, [email protected], is the author of “Stocks for the Practical Investor”. He manages several investment accounts.)