COMMON MISTAKES IN EQUITY INVESTING – how to save from the same
Let us consider some of the common mistakes investors make when investing in equity shares. Irrespective of whether they are experienced and seasoned professionals or first time amateurs all investors are susceptible to these mistakes. The market has its own method of finding and exploiting human weaknesses.
Let us try to explore and explain the eleven most common mistakes which investors commit while investing in common stocks.
1) Trying to catch the market’s Top and Bottom a.k.a Timing the Markets:-
This is a very common mistake which most equity investors commit, i.e. trying to catch the market very top and bottom. No government, no central bank, no company management, no fund manager, no analyst else knows what will be the next exact top or bottom of any stock. How then can an investor believe that he or she will be able to catch the market’s very top or bottom?
Instead determine the value and target price of any stock in which you intend to invest by whatever method you follow- fundamental, technical or any other-and then buy it within 5% to 10% range of the target price. You may also pace out the purchase over a period of time keeping in mind the current performance of that company and/or the overall market conditions. But once you have decided your correct price for buying a stock and once that price is approached, then don’t wait to ‘buy at the bottom” because you will probably never be able to do that. Remember that if you wait too long to buy, until every uncertainty is removed and every doubt is lifted at the bottom of a market cycle, you may keep waiting….. and waiting. The same rule also applies while selling.
2) Believing “The price will come back!”:-
This is another common mistake which most investors commit while investing in equities both when buying and selling shares. If they miss buying/ selling a stock at a certain price, they then keep waiting in anticipation that the same price will come back, irrespective of market or stock considerations.
For example, based on his analysis somebody might have decided to sell X. He had seen the price of Rs.y in January 2008 but “missed” selling at that price. After that the stock starts falling because of general market weakness and fundamental deterioration in the company. But investors who waited for the “price to come back”- might still be waiting. The stock’s price hit a low of around Rs. Z- and who knows whether or when the price of Rs.Y will ever come back! The lesson to be learned is that if the price of the stock has gone up – or gone down- because of a change in the company or sector’s prospects then there is no point holding on the illusion that the “price will come back”.
3) It has already Fallen so Much——- It Can not fall any further:-
This is another serious mistake which many investors commit while investing in equities. A stock falls “considerably” and they believe that it cannot then fall any further. Nothing can be farther from truth. In fact this is one of the gravest mistakes which results in multiplication of investor losses. Continuing with the Company X example, the stock fell from Rs. Yin January 2008 to RS Z by march2008, a massive fall of 45% in just two months. An investor who believed that it couldn’t fall further because it had fallen 45% in two months and hence held on to it –or purchased it— was in for a rude shock as it fell to RS Z by December 2008, A massive 96% fall from the top and also a substantial fall of 92% from the march 2008 level of Rs. Y. Unless the stock again become attractive on a stand alone basis, there is simply no logic in thinking that “because it has already fallen so much it can’t fall further..
4) It is Already Gone Up so much—- it can not rise any higher:—
This is the corollary of mistake number three—many times investors believe that since a stock has risen so much, it cannot rise any further.
For, example, Titan rose from around Rs. 5 in July 2004 to RS 42 by march 2006, a stupendous, jump of more than 8- fold in less than two year. Anybody who sold it believing that the stock had already risen a lot and therefore wouldn’t rise any more was in for a rude surprise as the price rose to RS 290 by November 2012, not only swelling 58- fold from it July 2004 price of Rs. 5 but even multiplying by around 6.9 times from its march 2006 level of RS 42. Hence, unless the stock becomes expensive on the basis of valuation, expectations of future growth, or any other “price determination” parameter which you might be applying, there is no reason to sell a stock simply because it has risen so much.
5) Protecting your profits or cutting your losses:—
Many of you might not agree with me on this point. Unless you are a short term trader or investing using costly leveraged funds, there is no point in simply trying to protect the profits or cut losses You should sell if the stock become costly on valuation basis, or its fundamentals deteriorate on a long term basis. Just because a stock on which you are making money corrects. It does not mean that you panic and sell it to protect your profits. Let us continue with the example of Titan.
After rising about 8-fold from Rs. 5 in July 2004 to Rs. 42 in march 2006, i.e. in just two month, Titan stock price corrected to Rs. 21 by May 2006 .i.e. it fell to almost half of its peak price of march 2006. An investor who panicked and sold the stock then would have been in for a nasty surprise as the stock then went up to Rs. 85 by December 2007, i.e. a 4-fold jump from its may 2006 low—and then beyond that to touch Rs. 290 in November 2012..
The same principle would apply for cutting losses as you might be cutting your losses just before the stock is on the verge of embarking on its dream run. Let’s continue with the Titan example, Suppose you purchased the stock at RS 42 in march 2006. It halved to RS 21 in the subsequent two months and you were nursing a massive 50% loss. Now, had you sold the stock at RS 21, then you would have sold it just before it was getting ready for its next dream run which led to manifold price multiplication over the next few years. So, the lesson is: sell the stock only if after your analysis you feel that the price is right for selling and not on the misleading notion of protecting yours profits. By doing the latter you might in fact be eliminating any probablity of serious wealth creation in the future.The same applies to the “cut your losses” fallacy as well.
6) Price Averaging :-
This is another loss-making mistake which equity investors make. There is a wrong notion that bringing down the purchase cost by averaging would enable you to sell at some marginal profit or, at least closer to your cost price. Let us return to the example of Company X suppose you invested in the share at Rs. X in January 2008, then “averaged” by buying another share at Rs. Y in February 2008 and further averaged by purchasing another share at RS Z in march 2008. Now your reduced “average cost” per share is Rs A. But what quoting around RS B, down by a phenomenal 91% from the reduced “averaged cost”
One caveat; sometimes an investor might get an opportunity to exit the averaged stock at close to the “average cost” but such opportunities are rare exist only for a short time and are therefore very difficult to capitalize on.
Finally, if you would not otherwise buy a stock at a particular price then what is the logic for averaging just because you already own it? Remember, never throw good money after bad. If you have made a mistake in selecting a wrong stock, humbly accept your mistake, sell it, book your loss move ahead and utilize the proceeds to buy better investments with potential of future price appreciation.
7) The Market Trap—Stock has Gone up so I am right or stock has gone down so I am wrong:-
Ego and lack of self-confidence are both negative qualities for an investor. If you a stock and it goes up for no real reason but because of irrational market behavior, then be smart and sell it and get out instead of [am[erring your ego by thinking that you are an astute investor or a great stock picker. In other words, never confuse bull markets with intelligence. Remember, that the market is a great deflator of all egos. The same holds true when you might have invested in a stock at a decent price after a thorough analysis and the stock falls not due to any deterioration in the company’s performance but for some uncontrollable market reasons. At such times there is no need to panic, lose self confidence and start believing that you were wrong. Remember that the market can also be wrong and is, in fact, wrong most of the times. Try to take advantage of its abnormalities by using your knowledge, experience and judgment instead of getting swayed by it losing your self confidence,
8) Efficient Market theory:-
Do not blindly believe in the efficient market theory. In fact, remember that the market is inefficient almost 95% of the time—it’s like a pendulum moving is inefficient almost 95% of the time—it is like vice versa. Like a pendulum moving from one side (over-valuation) to the other side(under-valuation) , the market only sometimes that is passes through the middle (far valuation). Having said that, over the long term the pendulum does move in the right direction—if the country, economy, sector and the individual stock perform well, then over the longer term, the pendulum, too puts its weight behind them..
9) Blindly following a guru:–
There is a saying that either you completely trust your judgment or the judgment of another person. And that other person in the market is the investment guru or fund manager, etc you many trust any investment guru of your choice and, indeed, some investor gurus will periodically beat the market but it’s worth noting that even all investment gurus together cannot beat the market on a continuous basis because they themselves make up the market! Simply put everybody can’t beat everybody for there to be a winner, there has also to be a loser. And, kindly note the buyer and seller are always on the opposite side of the trade and they both mysteriously believe that they are right but one of them is, in fact, wrong! So don’t trust any of the so-called investment gurus at face value (including myself, although I don’t claim to be an investment guru but just a student of investing). Most of the, the guru will not advice what he believes is right but in fact say what you want to hear. Research and analysis do not always work in the stock market but the jobs of analysts are always secured. So, bear these points in your mind before selecting your guru.
10) Buying Penny Stocks:-
This is another common mistake which most investors commit they buys penny stock, i.e. stocks with low price, thinking that the price is already so low, most probably in single digits, that it can not go any lower, little realizing their folly. In the pursuit of buying cheap stocks, they end up investing is reported in percentage terms and measured in rupee terms. Whether it be a penny stock of RS 1 or a high priced stock of RS 1,000. Therefore, if a RS 1 stock falls to 10 paisa or a RS 1000 stock falls to RS 100, the loss in both case is 90%. And, most importantly, if you invest, say RS 1000 in either of the two stocks and both of them become zero, then you lose your entire investment of RS 1000 irrespective of the stock initial price so, remember the old saying penny wise, pound foolish. The stock price is just a quote in the market and on its own does not have any significance whatsoever.It has to be measured in conjunction with the company performance, earnings, book value, dividends, etc. A high priced stock many actually be cheap on valuation basis while a low priced penny stock may in reality be very costly if the underlying business does not support even that….
11) Failure to Pass the Test of Patience and character:-
The market is a place which will test your patience and character. Many times you might have bought a stock for all the right reasons and at the right price but the stock many still not go up for a long period. You many have just hung on thinking that the day you get frustrated and sell it, there are chances the stock will then start rising, Hence patience and character are key virtues which will be repeatedly tested by the market. Remember, whether in life or in the market, you must never quit when things seem to be the worst, inevitably, good times follow bad times.