Most people focus too much in making money in stocks. In fact, we should learn how NOT to lose money in stocks. When we take care of downside (possible way to lose money), upside would take care of itself (making money naturally).
Let’s learn what are 6 common ways to Lose Money in Stocks, solutions are given to reverse the probability from likely to lose money to likely to make money in stocks.
1) Buy Cheap Stocks regardless of business fundamental
This is a common mistake for novice investor, especially focusing on historical low share prices to buy low or buy cheap, ending up lower or cheaper share prices over the time, therefore a loss. There is always a reason for stock prices to fall down, eg. market fear, declining business, negative news, etc. If the share prices fall down to low optimism due to declining business, this is a low quality opportunity.
Solution to Make Money:
For every low or cheap prices, double check the reason of falling. Fear driven (eg. market crisis while fundamental is strong) is better than weak business driven. Combine TA (price) with Optimism and FA (business), don’t buy just based on “cheap price”. Only consider giant stocks (strong business fundamental) before considering lower prices with TA or low optimism opportunity.
2) Buy Low for Share Price with Downtrend
Trend-following is critical, especially for short term to medium term trader. During market correction phase, when trend is bearish, action to buy low could end up lower in share prices, even the business fundamental is strong.
Solution to Make Money:
Align buy low with uptrend of prices, shorting with downtrend of prices. At least wait for price breakout the next resistance before buying, breakout the next support before shorting.
3) Buy Crisis Stock without protection
It is nice to buy crisis stocks, including giant stocks (eg. oil & gas / commodity stocks, China / Hong Kong stocks, casino stocks, etc) when share prices drop to less than 1/2 or 1/3 of prices, even at low optimism. Sometimes, the crisis could be so severe, even a giant could fall down and business could go bankrupt due to unexpected crisis beyond the risk tolerance level of company, eg. short term cash is insufficient to pay for short term debt, resulting in selling of valuable assets, increasing the market fear to drive down the share prices further. Investor could suffer huge loss this way.
Solution to Make Money:
It is fine to take risk for crisis stock but one has to limit the capital allocation (eg. less than 10%) for speculative investment. To take calculated risks, focusing in crisis stock with business which has strong sponsor (major shareholder with > 30% share), debt/equity < 1, sufficient cash to pay for short term liability. For trading, always apply SET in plan: Stop Loss, Entry Price, Target Profit. The Stop Loss is a natural defense system, especially there is insufficient diversification but Stop Loss should not be abused as random trading with SET would not give an edge, decision on SET should be based on Optimism, FA (Fundamental Analysis), TA (Technical Analysis), PA (Personal Analysis), etc.
4) Buy only a few good stocks
There is always uncertainty in future business, even a stock is doing well today technically (prices) and fundamentally (business), it does not mean they will continue to do well in future. Sometimes unexpected business risk (unsystematic risk) related to company scandal, hidden risks, management issues, etc, could affect the company business and share prices. If an investor invests in only a few stocks (eg. less than 5), even they are strong fundamental / technical stocks, when unexpected crisis comes, the loss could be tremendous.
Solution to Make Money:
A smart investor would need to have at least 10 stocks for diversification, ideally distribute over giant stocks in various sectors and countries to avoid the concentration risk of a few stocks. Having 10 stocks could help to minimize unsystematic risks significantly related to business / operation in future.
5) Focus only in individual stocks (Level 1)
No matter how strong is one’s analysis (eg. Optimism + FA + TA + etc), even with enough diversification (10 or more stocks), if there is misalignment between individual stocks and mega trend of stock market (eg. country), one may suffer eventually. Country and world stock indices represent the money flow of smart investors and big funds through blue chips, prices go up when money is flowing in, prices do down when money is flowing out. If the stock market is bearish, 90% stocks are falling down with only 10% stocks are uptrend, even a trader is aligned to buy low with uptrend, the probability of success is lower as it is against the higher Level 2 (sector), Level 3 (country) or Level 4 (world).
Solution to Make Money:
There is no need to diversify into too many stocks (eg. over 100 stocks) because this could not fight against the systematic risk (eg economic cycles), which can only be minimized with investing in low optimism stocks aligned with Level 1 (individual stock), Level 2 (sector), Level 3 (country) and Level 4 (world).
6) Personality Mismatch in Strategy
Even if one could learn the best method or strategy but misaligned with own personality, results could be negative. A short term trader may lose money if buying an undervalue stock at low optimism but not having patience of a few years to hold for recovery and capital appreciation. A long term investor could also lose money when buying a strong giant stock at high optimism price with downtrend in short term prices as the minor correction in share prices could become a major global financial crisis if trading is not integrated into investing.
Solution to Make Money:
Perform a personality test on inclination towards trading (short / medium terms) or investing (long term / lifetime). A successful trader or investor has to align the trading plan or investing strategy with unique personal condition (eg. reward expectation, risk tolerance level, health condition, capital amount, time resources, technical knowledge, response time for actions: Buy / Hold / Sell / Wait / Shorting, etc). Knowledge could only be translated into fortune through taking at least 1 action (which may not be Buy or Sell) which has to be aligned with own unique personality.
The right or wrong in strategies above very much depend on one’s personality. Eg, a professional trader may not study business fundamental at all, applying pure trading (trend-following, following SET plans consistently, careful money management) with price actions, could also make money. Similarly, a smart investor could buy undervalue stocks with downtrend prices in contrarian way (buy when others are fearful) without consideration of TA, also could make money. However, for most traders and investors, it is relatively safer to integrate fundamental (FA) and technical (TA) with Optimism Strategies with alignment with own PA (Personal Actions).
Remember Warren Buffett’s first rule of investment: “Never Lose Money”. Based on my understanding, it does not mean don’t lose money at all. It means we need to have a strategy which aligns with our personality which eventually chances of winning is much more than losing money, therefore naturally one would “not lose money”. Even Warren Buffett himself has suffered 50% “loss” in share prices for Berkshire (BRK Class-B dropped from $100/share to $50/share) during 2008-2009 subprime crisis but he is confident to hold them through the crisis, share prices now is above $200/share, therefore he is “not losing money”. However, another person who copies Warren Buffett to buy the same stock portfolio but does not have the same faith, could suffer capital loss if Buy High Sell Low eventually for strong giant stocks.
Reader, consider other possible ways (eg. buy based on rumours / news / insider tips / own feeling) likely to lose money and propose a solution. Let’s avoid these traps in stock trading or investing. We can learn from mistakes, then the probability will change from losing money to making money in stocks.
You may learn 10 strategies (Optimism + FA + TA + PA) to make money in stocks from Dr Tee free monthly workshop, register in www.ein55.com
