The other day I got a call from a friend. He wanted to know my opinion on Stock A, which was proposed to him by an old hand in the stock market. He was told that the stock would double in a few months and the person who had recommended the stock also had bought some. I told him that this stock was crap and unless an operator was running the stock, I did not see strong reasons on why this stock would double. I said this not because I have the ability to spot stocks that will double in very short periods of time, but because I am yet to come across people or experts who can do this feat every time.
So in a nutshell I told him to stay away from this stock. Nevertheless he went ahead and took some exposure in the stock, as the seduction of making quick bucks was very high. Exactly 3 days down the line this stock is 18% down with 10% being knocked off in 1 day. He was now skeptical about making equity investments with the losses suffered in a couple of days. He blamed the stock markets as well as others for his misfortune, but at the same time wanted to participate in the growth of the Capital Markets and our economy.
However, never ever did this friend ponder over the mistake he had committed. I bet there are plenty of people who are guilty of committing the same mistake or others, but never get down to really understand what went wrong and try to learn from their mistakes.
So what are the important lessons for people wanting to create wealth through equities? The cardinal rule is to make as few big mistakes as possible.
Though the list can be pretty long, here are seven common mistakes people make when investing in equities and that you should stay away from.
Mistake No 1: The first and biggest mistake is not to admit making a mistake
People stubbornly hold on to stocks where they are making sizeable losses in the belief that they can exit when the price reaches their buying price. Most of the minds are not trained to acknowledge the fact that they have made a mistake and probably the best thing is to move on. There was this gentleman who had bought a penny stock at Rs. 9 following a tip and hoping that it would double in a few months. The stock first rose by 20% and then declined by almost 40%. He was unwilling to let go of the position with the belief that he will do so only when the price reaches his buy price and it will happen sometime soon. The gentleman is still holding on to the stock and the stock has lost a further 40%. He could have exited the stock with a loss of just 28% initially (considering the appreciation of 20%). Now his losses are around 56% and he is still holding the stock. This happened in October 2005. Even several blue chip stocks have actually doubled or tripled since then.
Mistake No 2: Buy on tips and khabars and wanting to make a quick buck
Technology has made our lives much easier but at the same time has caused a lot of overload as well. We are subject to SMSes , emails and flyers with lucrative offers for buy and sell tips , commodities trading etc. that at the end of the day leave you confused. In this state only two things can happen, (a) One is that you procrastinate and not take any action with the fear of screwing it up and (b) Succumb to these offers for making you rich quickly.
The point that I am trying to make is that how people who are conservative or sane can take dangerous calls and sabotage their own well being. I remember having met this conservative gentleman who was targeting only 12% returns but still could not resist the stock market temptation when the broker called and showed him some tantalizing figures.
Mistake No 3: Buying a loser on its way down thinking you are averaging your costs
Mistake No 4: Ignoring Risk in the investment and looking only at the returns
Risk is an integral part of every equity investment and some equity investments are more risky than others. People however look at the returns without giving due importance to risk. Stock Futures can give you great returns but at the same time they can wipe out your capital as well. In the mutual fund context, people look at returns when investing in the fund, but do not consider the kind of risks the fund manager has taken whether it be concentration in stocks or sectors etc. At the same time betting heavily in Futures & Options, Commodities without understanding the nuances of the same is fraught with risk. Understand the risk i.e the downside inherent in every investment and volatility associated with it.
Mistake No 5: Buying penny stocks thinking they are cheaper and ignoring stocks, which are priced above a certain number like Rs. 1000 thinking, they are expensive.
Mistake No 6: Exiting Winners early and sticking to Losers
Ask yourself Suppose I have a choice of 2 boats. Boat A is strong, consistent and has traveled the sea through many rough weathers as well. Boat B is showing some cracks and leaks in certain places. Water seeped in through this boat sometime back. Which boat will I choose to safely get me from this shore to the next? I bet all would opt for Boat A and no person in his right mind would opt for Boat B. Yet when this same logic is applied to stocks, people will stick to losers (Boat B) but exit winning stocks (Boat A) to make a small profit.
Mistake No 7: Just thinking but not doing anything
Finally doing makes all the difference. There is no substitute for action. Just knowing that exercise is good will not keep you fit. In the same vein, just knowing this stock is good is of no use unless you buy it.
I come across so many intelligent people who know many things but are simply unable to implement because of lack of time and busy schedules. I knew this stock would do well, wish I had put in money here or I missed a good time to enter this stock are some common responses you hear. Whatever the reason be, in the end what matters is whether you did what you knew was right. A better option for people here is to put their investments on Autopilot (Automatically investing fixed amounts every month in stocks and mutual funds).
To be a successful investor and create wealth through equities, you should shun the costly mistakes outlined. And yes if you have made any one of the above mistakes, admit it and correct it. More importantly Stop Hoping.
At the end of the day Hope is not a Strategy in the Equities Market.
The author is a practising Certified Financial Planner. He can be reached at firstname.lastname@example.org
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