Avoid these 5 Mistakes in Stock Markets

Avoid these 5 Mistakes in Stock Markets

The stock market has tremendous potential to earn high returns and enable you to achieve your financial goals. But it can be profitable in the long run if you avoid the most common mistakes listed below.  

Mistake 1: Trading or investing without a time horizon

It is OK for Warren Buffett to say that his holding period is forever. But even he did not hold on to airline stocks to IBM for too long. That is because even the legend invests with a time horizon in mind. We often see investors buying stocks and arguing that they are long-term investors when the price decreases. That is like being a long-term investor by default, whereas you should be a long-term investor by design. The thumb rule is to approximate how long you are willing to wait. It could be 1 year, 3 years or 5 years. That clarity is essential when investing, and it also simplifies other decision-making.

Let us turn to the practical side of the time horizon. Two crucial aspects in trading are stop loss and profit target. The stop loss protects your risk, and the profit target monetizes your gains. Entering the market without a stop loss or a profit target is a common mistake investors make because they don’t have a time horizon. Once you know your time horizon, you know how much risk you can afford to take and where to set the stop loss and the profit target for the position.

Mistake 2: Not doing enough research before a stock decision

Most investors are guilty of not doing enough to understand the company they are investing in. Saying you are not an analyst is irrelevant. It is your money, after all, so as well put the best foot forward. It is one thing to listen to your broker and the analyst’s views. You need to understand the stock, what the company does and its relevance in your portfolio. Is the company adding returns or just adding risk to your portfolio? 

Share market investing is not rocket science. You must understand the underlying story beneath the stock, for which you need to understand the business. One way is to stick to your comfort zone. For example, try investing in steel stocks if you are into the steel industry. That is just for example. You don’t control whether the stock goes up by 50% or 200%. What you control is risk and how you will deal with either situation. 

Here are some basic rules to follow. 

• Focus on risk more than the return of the stock
• You control risk but not returns.
• It’s a myth that low-priced stocks and P/E stocks are not value stocks. Many are trading cheaply because that is where they deserve to be. Quite often, stocks command low P/E ratios because either they are too leveraged, their profits are too uncertain, or they are in an industry where disruption is happening.

Mistake 3: Trading aggressively to recover your losses

There is nobody who does not make losses while trading and investing. The best investors get 60-70% of their trades right. Everybody makes losses, but the idea is to learn the lesson, cover the loss and move on. Investors and traders commit cardinal mistakes of overtrading to recover the loss. Remember, when you overtrade, you are not doing it in a proper frame of mind. That means you are likely to be led more by emotions than rational reasoning. That is bad investing strategy.

One risk of overtrading is that you inflate your risk. For instance, if you keep adding to a stock you are already exposed to, you are skewing the sectoral allocations. It does not matter whether you are loaded with money or not. At the end of the day, you come into the market with finite capital and finite risk-taking ability. That means you need to manage your risk to ensure you don’t lose more capital than you can afford.

Mistake 4: Averaging is not the answer to a falling stock

Let us say you bought Paytm at INR 2,000, and the stock’s prospects convinced you, so you bought more at INR 1,500. You continue doing that all the way down to INR 600. That is called averaging. You may believe it is OK to average because you buy the same stock at a lower price. However, averaging your positions comes with two key risks. Firstly, you made a decision, and it turned out wrong. By averaging, you are making the same mistake twice. Secondly, averaging can skew your ownership of some sectors and impact overall risk and performance. It is OK to have 5% of your portfolio in Infosys. If averaging takes Infosys to 25% of your portfolio, you have a problem on hand.

Investors often commit a related mistake of putting all eggs in a single basket. The message is that you must diversify! After all, we live in uncertain times, and you cannot just bet your bottom dollar on one idea or a few ideas. The answer is to diversify your risk to the extent possible. Diversify across assets, themes, capitalizations and sectors etc.

Mistake 5: Let us buy at the bottom and sell at the top

Timing the market may sound great, but trying to time the market can often backfire. Even the best traders and investors don’t catch the bottom or top of the market convincingly or consistently. After all, value is relative. A stock you liked at INR 400 is more attractive at INR 300. It then does not matter whether the stock goes to INR 280 or INR 260. You can never be sure of that.

Timing the market is generally a zero-sum game. Over some time, you will lose more money than you make. Instead, focus on stocks, stories and value. Do you know the key difference between successful and mediocre investors? Successful investors hold on tight when they are on the right track and are quick to exit when they are wrong. Mediocre investors do exactly the reverse!