Market Misconceptions: The 5 Biggest Mistakes Beginner's Make When Investing in Stocks
Updated: Jun 9, 2020
Once we start seeing some green on our investments, we tend to fall into the trap of believing we’re the next prodigy in the investing community: that intangible feeling of financial power...
I know I’ve experienced that in my stock market endeavors, and I’m sure some of you have too. For those of you who haven’t started investing yet, you get an exclusive insight into the biggest stock market mistakes people make from an early onset: not a bad position to be in I’d say, no?
Therefore, from archives of my own mistakes to excerpts from the most successful investors in the world, here are the 5 biggest mistakes you could make in the stock market as a beginner, and how to avoid them.
1. Thinking Get Rich Quick vs Get Rich Easy
Based on hundreds of surveys as well as personal experience, investing in the stock market tends to be extremely attractive to young people because it seems like a quick way to make money. Undoubtedly, it could be quick, but it’s not easy.
An established norm in society is that there’s no such thing as get rich quick: wrong, of course there is. You can sell a business and become a millionaire overnight; sell a piece of real estate and gain $100,000 in a week; or pick the right stock and make $40,000 in a day. All of these are Get Rich Quick schemes, but they are not easy.
While you could make a fortune in a day in the stock market, the process that’s behind picking the right stock is insurmountable workload, and very few people exude the effort to sustain such a level of diligence. So even if you get rich quickly, the process behind it was not.
Consider this example from none other than Warren Buffet: a man who supposedly reads 6 hours a day to analyze the market and deduce how certain companies will perform against future economic conditions.
"Read 500 pages like this every day," Buffett said to the students at Columbia, while reaching toward a stack of manuals and papers. "That's how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it."
Although you don’t have to be reading for a quarter of your day, the point is that you need to be doing substantial due diligence before thinking that you’re going to make money off a stock quickly. Start small and keep building up your level of research before picking a stock: grow your knowledge base like compound interest and watch as you ease through the basic difficulties and misconceptions of modern-day investing.
Hence, solidify that "Get Rich Quick" mindset by all means, but steer 180 degrees away from thinking "Get Rich Easy" ; if no successful investor ever believed in that, neither should you.
2. Temptations of Rising Charts and Daily Growth:
This was something that I suborned to far too often and it expunged my potential to make good profits: temptation. Almost every time that I saw a stock’s chart rising for several days, the immediate reaction was: “Surely this will keep going up if it’s done so for the past week?”
Aside from believing that your house is a cash-churning asset, believing that a stock will keep going up based on short-term past statistics is the 2nd biggest financial misconception of all time. Of course, if a stock has been rising over several months or years, that's a different story because it's likely that many other fundamental factors have substantiated that effect. However, several days of rising could just be a market overreaction to a new government policy, a big investment or good earnings: it's likely to be ephemeral.
Remember this: short-term past performance is never indicative of future results, so don’t make trades based on several days of rising stock prices.
Consider this example of temptation regarding Waste Management Inc. (NYSE: WM).
Here, seeing the general rising trend, you might think that now is a good time to be investing in this equity. Now, look what’s happened the day after the 4th of September:
Figure 2: Rising Chart of WM from 5th September till 13th September.
As you can see, WM’s share price was rising until the 5th of September, after which the stock dropped almost 10% in the subsequent 4 days; a perfect example to show you how buying a stock while it's already trendy is only going to cause you losses. If you “follow the herd” here, you’re already too late to catch the rising trend. Wait for the downfall and then pounce.
Pro-Tip to Control Temptation: In order to prevent yourself from being susceptible to rising graphs, open trades ONLY within one hour of the market opening, or one hour before its closing. This way, you won’t be able to see or be swayed by market conditions during the day: which is especially important because this is the time when it’s most common for stock charts to be volatile.
Overall, this point speaks to the fact that unless you were investing in WM for the long term, opening a position based on several days of rising stock prices would be risky. These are known as false-buy signals and you need to be acutely aware of them if you aim to be a successful investor.
3. Listening to “Expert” Suggestions
Perhaps the most popular rule I’ve read in a myriad finance books and articles is that experts are not the answer to your prayers.
While they are extremely well educated and have probably made a lot of money from the stock that they are recommending, it’s already too late to heed their advice. The trend has been caught by everyone by that point, so chances are that this “expert” we see on the news has already sold his shares and made a neat profit by the time he’s on the air recommending it.
A great quote I once read said that “Listening to “expert” recommendations on the news would’ve made me one hundred thousand dollars by now…if I started with ten million.”; this clearly depicts how expert stock recommendations are so tardily said that you’d only be able to make a 1% return at best.
If you want to profit in the financial markets, avoid listening to experts unless they explicitly prove that they are buying shares themselves when recommending the particular stock.
4. Not keeping liquid cash
It’s truly financial Christmas when the markets crash because everything goes on discount: i.e. it’s time to BUY BUY BUY! However, if you’re one of those people who put all their money into investments and have no liquid cash left, you're substantially missing out. Here's why:
Consider this scenario in the time period between September and December of last year for chip-maker Advanced Micro Devices (NASDAQ: AMD):
Within 3 months, AMD stock crashed almost 50%, which brought it from $32.61 to $16.65 by December 2018. Now, those investors who didn’t have anything left over suffered potentially thousands of dollars in foregone opportunities here.
Over the next 6 months, you can clearly see that the stock price regained its losses, which suggests that investors would’ve made almost 100% return if they bought this equity at its December low. Although, how would they be able to do that without liquid cash?
Tommy eagerly believes in the fundamentals of AMD, so he used $1000 – almost all of his available capital – to buy the stock in September 2018 at $32.61. While he aimed to hold this for the long term, his position value drops to just over $500 by December 2018 because the AMD share price nearly halved.
A low price is the best time to buy a valuable company that you believe in, but Tommy has no capital left to execute his trades. When the stock returns to $33.50 several months later, Tommy’s position simply increases to $1026.
$26 total profit? Tommy Loses.
Amelia holds $500 worth of AMD stock in September 2018. Because the stock fell 48.94% by December, her position is now only worth $255.29. However, Amelia has another $500 that she kept aside as a precaution for immediate purchases, which allowed her to buy some AMD shares for $16.65 during the downfall.
Later, AMD’s stock price rose to $33.50, which means that Amelia gained only $13.28 ( 1st position rose from $500 to $513.28), but she also gained $506.00 ( 2nd position size grew from $500 to $1006, as the stock price doubled).
Because Amelia had a certain amount of funds aside for unexpected stock purchases, she was able to buy AMD shares cheaply and was significantly rewarded.
$519 total profit? Amelia wins.
To quote Joel Greenblatt: “The secret to profitable investing is to figure out the value of something…and then pay a lot less.”
But, how do you expect to pay for shares of a potentially valuable company without the right funds kept aside?
5. Repeating a losing strategy
I once read that the most dangerous thing to say in the stock market community is “this time it’s going to be different.”
I must’ve said this damned line to myself a hundred times when I first started trading: believe me when I tell you that it lost me A LOT of money. When you begin to lose a large percentage of your portfolio after repeating the same tactics, you need to start thinking about the effectiveness of your trading strategies and whether they're statistically bringing you the emoluments you initially aimed for.
I didn’t include not having a strategy as one of these 5 mistakes because it’s fairly obvious that you need to have one; what’s perhaps not as obvious is that you have to keep improving your strategy if you’re not seeing good results.
Remember this: the definition of insanity is repeating the same thing and expecting a different result.
If you want to indulge in juicy profits and are currently unable to do so, take some time and re-evaluate your strategy: it'll pay off in the long term!
Instead of spending 1 or 2 years in the stock market and learning these 5 different mistakes from practical experience, you have a clear guideline in front of you before you've even started.
Ensure to watch out for any of these factors before making an investment, and you'll assuredly begin to see a limited amount of position depreciations each month.
As Warren Buffet says: "Rule number one in the stock market: don't lose money. Rule number two: never forget rule number one".
Keep these aforementioned aspects in mind, and you'll be much less likely to lose money in your investing journey.