It is a well-known fact in stock markets that retail fail to make money. But the reasons behind this failure are seldom discussed. So, let’s understand 5 common mistakes that first time investors make in detail:
1- Lack of Knowledge
The reason why the retail fails to make money is lack of basic as well as practical knowledge, and experience. It is disheartening to see beginners and retail lose their savings and hard-earned money into nosediving and falling stocks. No sane person would invest into a bad business, if they knew that the business is not profitable.
So, the most common and biggest mistake that rises to the surface is trading and investing with the lack of knowledge. Beginners invest into businesses and companies which they have no idea about. Therefore, the chance of losing entire invested capital is higher even if momentary gains are made. With little, incomplete or no knowledge one might lose possible profits just because of panic, news, or a tip.
Thesolution for this problem is very simple. Make time to learn before you anticipate earning. Either start with a share market learning course or learn from videos and interviews of the best creators, and investors along with their articles and blogs. Do not invest into tips or recommendations shared by anyone as everyone has different financial goals and risk appetite. To begin with, start by first researching about the companies whose business model you understand and investing only.
We get it, it might seem difficult, so let us explain this to you with an example. If your favourite chocolate is KitKat, look for the company which manufactures it. Now, start by looking at what the company does, other products, its financial sheets and management. To understand a financial sheet, you would need knowledge where the share market courses online,or the above-mentioned resources would prove to be useful.
2- Irrational Decision Making
Majority of the beginners have little to no control over their emotions when they are active in the markets. If the find a stock is rising, succumbing to their FOMO, they will buy blindly. As soon as they see the same stock making two red candles simultaneously, they will panic and sell, or a few of them keep it for the long term. This is simply irrational decision making and second biggest reason of the failure of beginners in the stock market. If you’re someone who just can’t avoid looking at your gain every 5 seconds even after placing target and SL orders, then you’re a victim of this problem.
The solution to this problem is building patience and conviction with your trades and investments. Unfortunately, this can’t be learnt from a book or a video but rather be developed. If one has knowledge about fundamentals analysis of stocks, then they will never be out of their investment until their goal is complete or the fundamentals have changed. They will realise it that the markets are a game of patience when it comes to investing. One with sound knowledge of technical analysis of stocks, learned form share market classes or online resources will understand that if a trade is taken, then there are only two possible outcomes- Target or SL. There is no point panicking by watching two three red candles or some third-world candlestick pattern forming. This conviction comes only when one has full faith in their trading strategy gained by thorough back testing.
3- Loss Aversion Bias
Usually, majority of the beginner’s portfolio is filled with loss making stocks. Have you ever wondered why?
The real reason behind this issue is the newbies selling of their good stocks at small profits and hold their loss-making investments in hopes that they will provide at least a breakeven in future. This psychology and problem are loss-aversion bias. It is the tendency for people to prefer avoiding losses than obtaining gains. Hence these new investors refuse to sell loss-making investments even when they know that they have made a bad investment. A few of them even buy more to breakeven when these loss making stocks fall further.
The solution to this critical problem is portfolio rebalancing through which one sells a fraction of their least performing stocks and reinvesting it into the more profitable ones. Since it is a periodic activity and not the complete loss-making portfolio is sold at once, the mind can be tricked. When the activity is conducted several times, profitable result helps in eliminating this bias.
4- Little knowledge of Risk Management and appetite
If you ask a beginner, how have they invested, some of them will say that they have invested by taking a loan or borrowed it from parents or their near and dear ones. Even the beginner traders will admit taking high leverages up to 5 times if their starting capital is small. The problem here is the failure to understand that leverage is a double-edged sword. Stock markets are not a place where you could always generate money. There are periods of correction and consolidation too where making money is tough even for experts.
The solution to this is understanding the risk you can take. You can only invest and trade with the money you can afford to lose. How much risk is fair? It depends on your age financial goal, financial capabilities, time frame of investment, income requirement, wealth requirement and many other factors. So, the next time you’re thinking to take leverage ask yourself this- What if I lose the leverage capital? Will I be able to pay back the leverage amount?
5- Over Diversification
If you see a beginners’ portfolio, you will see fifty or even hundreds of companies piled in them like garbage. Even an expert will fail to recognise the names of several in them. When analysed, a major chunk of these companies has a market capital of less than even 1000 Crores. Some of the beginners have a portfolio in which the market capital of all the stocks combined fail to reach 3000 Crore mark. These portfolios simply vanish when a major correction arrives leaving the investor devastated.
There is nothing wrong in having one or two small cap stocks in your portfolio, but your portfolio should be well-diversified among small cap, mid cap, and large cap companies. As a beginner invest only that much money that you are okay with losing, and more into large and mid-caps. Also, they should never invest all in one go but rather go for SIPs in good stocks or Index funds.
As someone who provide share market learning course, trust us when we say that we all have committed these mistakes at some or other point of our investment journey. It is better to accept and contemplate on our mistakes, rather than ignoring them. There is nothing wrong in making mistakes, but very much wrong in repeating those same mistakes. Afterall, earning comes secondary to learning.