You might have heard from many investors that the stock market is not gambling because you are not buying lottery tickets; you are buying companies. Either way, you are losing a lot of money in the stock market.
As a whole, people lose money because they do not understand the company they are buying. That means understanding the business model, the competitors, market segment, and future challenges. In general, if you can explain what a company does in less than 30 seconds, then you know the business.
There are many other reasons why people lose money in the stock market. Even the most experienced investors can lose money sometimes because no one can predict the market. However, few winners can offset the losers. Therefore, you must practice due diligence to minimise your risks when investing.
The following are 10 reasons that could make you lose money:
1- Over diversifying
Diversifying is good if you invest passively through an index fund. Index funds give you the average of a specific market by tracking the top companies in that market; that is why diversity makes passive investing successful.
However, this is not the same when you are picking stocks. When buying individual stocks, you are relying on your knowledge and understanding of the company. Therefore, you should not over diversify because you will end up buying companies you do not understand, and that can make you lose money quickly.
2- Copying others portfolios
It might look like a smart move at first, but it is not. If you have decided to copy super investors’ portfolios by using websites, such as dataroma.com, those portfolios are uploaded months after the investors change their portfolios. Therefore you might be buying stocks when the price is high.
Even though you have access instantly to someone else portfolio, you should not copy it because their edge in the market is different from yours. However, you can use those portfolios to get an idea of what companies people are investing in where you can invest after doing your analysis.
3- Buying stocks because they are cheap
Just because a stock is trading below $5 a shear, that does not mean that the stock will go up, or it is a much better investment than buying a company trading at $50 a shear. Therefore, if you invest equal amounts in both $5 company and $50 company, the loss is the same when the stock is zero. That is why it does not matter how many shears you won in a company because a loss is a loss.
4- Selling when stocks go down
This is one of the rockiest mistakes investors make. If you sell when the stock goes down, you will never make a profit. The market is volatile in the short term, so if you bought a company you understand and think the stock will go up, it could still go down. Therefore, do not give up on your investments when the stock goes down and learn to control your emotions.
5- Not researching the company management
The Management and the CEO control the future of the company. Therefore, you should do more research into the management to understand the people who run this company. I have written an article that explains how you can assess the company management before buying stocks; you can check here.
6- Not checking the company financials
If you are not doing this, you are gambling and buying stocks like lottery tickets. You need to understand the position of the company financially and look at important numbers, such as growth rates, return on invested capital (ROIC), equity, cash, sales, long term debt, Earnings per Share (EPS) and Price to Earnings ratio (PE) … etc.
You must see increasing trends in those numbers and make your decisions based on the company’s performance in the past five to ten years before purchasing a stock.
7- Paying too many fees
To get the maximum return on your investments, you have to minimise your expenses. Therefore, you should research how much you pay in fees, subscriptions, and conversation rates compared to another brokerage. Pick the cheapest that suit your average trading volume and the number of domestic and international shares you buy.
If you found you are paying too much, you can transfer your portfolio to a cheaper brokerage. Avoid paying subscription fees if you trade stocks occasionally and high conversion fees for international stocks. You can own multiple brokerage fees based on the type of investments to lower your fees.
8- Relying too much on technical analysis
Although technical analyses are an excellent way to time your entrance and exit to the market, they are not always accurate in predicting the stock movement. Because they can not tell you the company position financially, that is why you should rely on fundamental analysis when valuing stocks and using technical analysis as a helper to see where the market is going.
9- Not using a margin of safety
The factor of safety is what super investors use to buy stocks. Even if you are confident of your stock evaluation and can determine the Intrinsic value, your estimate is not always accurate. You can use a factor of safety to minimise the errors in your assessment. The margin of safety could reduce your losses significantly if you made a mistake in your analysis.
If you want to learn how to calculate the factor of safety, I made a full example calculating the factor of safety using excel you can check here.
10- Not being patient
If you are investing with the mentality of getting rich quickly, you are making a big mistake, and you are likely to become a day trader. Investing is about being patient and waiting for the right moment. If you find a good company with an overpriced stock, you should wait until the stock is available at the Margin of Safety price. That is how investors such as Warren Buffett and Charlie Munger do it.