Whether you’re seasoned or a novice, every investor makes mistakes when it comes to the stock market. In fact, mistakes are part of learning about stock market trading. Even the greatest investors in the world are still learning.
Understanding the nuances of the stock market is a lifelong learning experience. Below you’ll find a list of 10 of the most common stock market trading mistakes. It’s important as a trader to know both what to do and what not to do. Learning what to avoid will help you expand your knowledge of the stock market, decrease your chances of making mistakes, and increase your chances of making consistently profitable trades.
1. Skipping the Due Diligence
Warren Buffet, arguably the best living investor, only invests in what he understands. If he doesn’t, he walks away. It’s a good strategy. Why? There are no sure bets when it comes to investing. Investing in a stock you know nothing about means you’re just throwing your money away. If you’re going to invest your hard-earned money, you need to do some homework. That means checking under the hood and getting a thorough understanding of the company’s fundamentals and technicalities. This will help you understand what you are investing in, the strengths and weaknesses of a company, and an entry and exit point.
2. Following the Herd
Understanding a stock takes work. Listening to a hot stock tip at the water cooler and following the herd doesn’t! A lot of investors take short cuts when it comes to finding stocks to invest in. That can include listening to friends or coworkers, an unsolicited e-mail touting the next big ten-bagger, a talking head on TV, or a press release. This strategy is bound to backfire. There might be safety in numbers, but not on Wall Street. The biggest profits are made by those who find a stock before everyone else does. Form your own opinion and invest with confidence.
3. Picking a Top and Bottom
It’s temping, but don’t try to time a market top or bottom. Investors understand that markets move in cycles; markets climb, hit new records, correct or crash, then enter a cycle of growth, and hit new record levels. This does not mean that investors can accurately predict when the markets are going to top out so they can sell, or bottom so they can buy. Looks simple, but no one has ever been able to do this consistently through the various stock market cycles. Trying to time the market will lead to more losses than gains. The best way to profit is to understand the stock and wait for what you believe is a good entry and exit point. Doing this will help you increase your odds of making a profit and reduce the risk of a loss.
4. Falling In Love with a Stock
It’s easy to do. You spend a lot of time researching a stock, find one you think is undervalued, and take a position. Then the share price falls. Instead of selling though, you hold on, hoping it will rebound. It’s okay to love a stock when it’s doing well, but when it’s not, sell it, free up some cash, and invest it elsewhere.
5. Never Admitting Defeat!
A smart investor knows when to get in and when to get out. Even if it means admitting you made a mistake and taking a loss. Before you make a trade, decide where you want to get in and what losses you’re willing to take. Then stick to that plan. Holding losses for too long, hoping the stock will make a 180 degree turn will just translate into more losses. After all, it takes a lot for a stock to get back to where it was before it fell. If you buy a stock at $10.00 and it falls to $5.00, it’s lost 50% of its value. For that stock to get back to your entry point, it needs to climb 100%. That’s not an easy task.
6. Avoiding Stop Orders
Stocks can soar and plunge in a heartbeat. Not paying attention to your portfolio can lead to massive losses and missed opportunities. Unfortunately, few investors have the time to sit at their computer and watch the markets all day long. The easiest way to protect yourself against an unexpected loss is with a stop order. A stop order (or stop-loss) is an order to sell a stock once the stock hits a specified price. If a stock is trading at $10.00 and you place an order to sell at $9.25, your order will be filled when the stock hits $9.25. It’s better to be a proactive trader than a reactive one.
7. Being Greedy
Everyone likes to make money. That’s the entire point of being in the stock market. But it’s a double-edged sword: you don’t want to let a losing trade get out of control, but at the same time, you don’t necessarily want to be greedy and let profits run either. If a stock has made solid gains and reached your target price, it might be a good idea to sell the entire position or take profits. Holding out for too long can lead to profits being slowly eroded away. Wait too long, and your profitable trade could be a loss.
8. Averaging Down
Averaging down is when you purchase additional shares of a stock after the price has fallen, thereby decreasing the average purchase price. If you bought 10 stocks at $5.00, your average is $5.00. If the stock falls to $3.00, and you purchase an additional 40 shares, your average is now just
$3.40. While this strategy can work if the share price rebound, if the price continues to decline, it can also get out of hand very quickly, and you’re left with a huge losing position.
9. Holding on to Your Opinion no Matter What!
As a trader, you can’t afford to be a perma-bull or -bear. Stock prices don’t rise and fall based on your personal belief system about the Federal Reserve, quantitative easing, precious metals, or emerging markets. A stocks profitability relies more on math and a broad scope of factors than what you believe in. It’s better to be a detached, objective observer than an active, subjective participant.
10. Holding on to Your Position no Matter What!
A billionaire investor like Warren Buffet can live by the mantra “Our favorite holding pattern is forever,” but most investors can’t. Know when to cut your losses. Your money can go to better use elsewhere.
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