Investing in the stock market is one of the best things you can do with your money, provided that you know what you're doing. If you don't know what you're doing, you might as well take your money to Vegas -- you might even get better odds. But if you're going to play the market, do it right.
Here are some common mistakes investors make. Know them and avoid them.
1- Timing the market
Market timing isn't something for the individual investor (in fact, in some cases, it can be illegal when done by mutual funds). The basic idea is to buy at a set price at the end of the day (often we're talking about buying mutual funds, not individual stocks) and then selling on the next trading day (assuming the price rises).For the individual investor, this practice seldom makes sense for two reasons: first, mutual fund rules make buying and selling costly, so profits are eaten by fees; second, the gains are fractions of pennies, so few individual investors have the cash to make these transactions worthwhile.
What to do instead: In short, don't do it. If you're investing in mutual funds, look for a solid fund. But if you've got the itch to make quick trades, look into trading individual stocks after hours.
2- Buying a stock because it pays a dividend
A profitable corporation can distribute profits in the form of dividends. In other words, each share gets a certain amount of money. While it's great to get a dividend, it's not wise to hunt them. So, the mistake that a lot of guys make is to buy a stock shortly before they expect it to pay a dividend.While that sounds good, the problem is that the price they pay for the stock likely reflects the anticipated dividend. In other words, shopping for dividends means you're overpaying.
What to do instead: It's good to have dividend stocks in your portfolio, but they're not the only way of making money. Instead, hold a diverse portfolio, knowing that some of your stocks will likely pay a dividend and others won't for a very long time (if ever). If you do that, you'll find that you're one step further on the road to holding a collection of blue chips (which tend to pay dividends) and more speculative securities (which may be years away from profitability, despite increasing stock prices).
3- Buying a stock before an earnings report
An earnings report is like a quarterly scorecard from a company. But before that scorecard is released, market analysts spend their days making predictions. Most companies meet or beat expectations. The mistake, then, is taking an earnings report too seriously because meeting or beating earnings just isn't news. So, if your strategy is to speculate based solely on earnings reports, you'll be basing your predictions on accounting tricks.What to do instead: Earnings reports have their place, but you want to use them as a signal. What should you be looking for? The company that doesn't meet its earnings.
Why?
Well, it may be a good investment, depending on why it didn't make its earnings and what it can do to change that (you'll have to investigate). But in the meantime, the stock price has likely gone down, which means there could be an opportunity for you.
4- Buying into the hype
Remember Pets.com? It was pretty much the poster child for hype in a boom market. In fact, there was so much hype around Pets.com that Jeff Bezos (CEO of Amazon.com) later confessed that investing in that company was one of his biggest mistakes. But what happened to Jeff happened to a lot of guys: They got carried away by the hype (and by a stock price that grew in leaps and bounds daily). In the end, the company was worth nothing.What to do instead: It's easy to tell you not to believe the hype. But that is, in essence, what a lot of guys should do. Few companies out there can live up to the hype, so you should take it with a grain of salt. When you see a rocketing stock price and all you hear is about this hot, new company, think to yourself that these are warning signs, not investment signs. Remember; living up to that kind of hype is a once-in-a-lifetime investment.
5- Assuming that if a stock price is low, it's good to buy
Buy low, sell high, right? Well, maybe. Just because a stock price is low, doesn't mean it's a good buy. And, conversely, just because the price is high, doesn't mean it's a bad buy. The mistake is not knowing that "buy low; sell high" is really shorthand for "buy stocks that are undervalued and sell stocks that are overvalued."What to do instead: High and low are relative terms -- $300 may seem like too much for a stock, whereas $3 might seem like a bargain. But you have to put the trade in context. Ask yourself if the company is under- or overvalued at its present price, based on market cap and P/E. That's the mark of a good or bad buy.
6- Blindly following the lead of an anchor investor
Sometimes it's easy to get the business page confused with the gossip column; after all, both do a ton of name dropping. A lot of guys make the mistake of following a big-name investor like Mark Cuban or Kirk Kerkorian.The even bigger mistake is thinking that by copying them, you're guaranteed a payday. First, there are no guarantees. Second, even if they are right, they haven't told you their strategy, so you won't know when to sell.
What to do instead: You should follow what some of these investors are doing (if only because they have the capital to move markets). But by follow I mean pay attention to, not copy. In short, know everything you can, but think for yourself.
7- Not cashing out & locking in your profit
At some point, you need to take profits. But when you take profits (sell), it can make all the difference. The truth is that there is no easy answer for this. Sadly, a lot of guys get a gambler's mentality when it comes to profit taking. That's the mistake. Or, they see a little bit of profit, and hit the panic button and sell too soon. That too is a mistake.What to do instead: Look at the profits (rate of return) that are common to the sector. The key is to be realistic. What you need to do is stay disciplined and not get greedy or scared. Plan your profit taking as carefully as you plan your investing.
8- Not cutting your losses
Stocks move up and down. But sometimes a stock suffers a steady decline. Surprisingly, some guys see that happening and they root for their stock like it's their favorite sports team. In other words, they become emotional. Day in and day out, they obsess over a declining stock price as they lose more and more money.What to do instead: Short and sweet, sometimes you need to cut your losses. Success is a relative term when it comes to investing. Ideally, we think of success as how much you make. But sometimes success is about how little you lose. A smart investor not only knows when a stock is in a tailspin, he has the courage to let it go, so he can take his money elsewhere and start making it back.
invest in the market to make money
They call it playing the stock market, but for anyone who has ever lost money investing, it's no game. Unfortunately, making money isn't a science either. Investing is an art form, but with each trade you can get better and better. So the best thing you can do is learn, learn, and learn some more.Now that you've seen eight common mistakes (and learned from them), look for my next article, which will cover eight more mistakes that investors make.
Resources:
http://money.cnn.com/2005/08/26/markets/hedge_timing/index.htm
http://www.allbusiness.com/articles/PersonalFinance/4004-2419-2424.html
http://slate.msn.com/id/2118232/
http://www.fool.com/news/commentary/2005/commentary05060202.htm
http://biz.yahoo.com/special/mistakes04.html
http://www.rediff.com/getahead/2005/jun/07stock.htm
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