Eleven Deadly Sins of the Individual Investor
Knute Rockne, the famous Hall of Fame Notre Dame football coach, used to say, “Build up your weaknesses until they become your strong points.” The reason most investors constantly loose money in the stock market is they simply make too many mistakes. It’s the same in your business, sports and life in general. You never fail because of your strengths. It’s always the mistakes or weaknesses that you do not recognize and correct that bring you down. Most people just blame somebody else, such as your advisors. It is much easier to have excuses than it is to examine your own behavior realistically. Don’t feel bad. It’s human nature. From my years in the industry, managing the emotions of hundreds of investment clients and endless research, I’ve identified the Eleven Deadly Sins of the Amateur Investor. Study them closely, educate yourself and arm yourself with knowledge. It’s imperative to your investment success.
Brent Virkus - President and CEO of TRiTON Capital Advisory
#1: Living in denial and stubbornly holding onto your losses when they are very small and reasonable.
Most investors could get out quickly when they have made a mistake, but because they are human, their emotions take over. You don’t want to take a loss, so you wait and you hope, until your loss gets so large it becomes almost impossible to recover. From my experience managing client emotions, this is by far one of the greatest mistakes nearly all investors make. As the world famous investor William O’Neil say’s “All stocks are bad. There are no good stocks unless you make money when you sell”.
Without exception, you should cut every single loss short. The rule I have taught all of our investment clients is to always cut all your losses immediately when a stock falls 7% or 8% below your purchase price. Following this simple rule will ensure you will survive another day to invest and capitalize on the many excellent opportunities in the future.
#2: Buying what is down in price rather than a stock making new highs.
I used to get this call all of the time from my clients. “Hey, XYZ is down over 10% today. Let’s buy some. It’s a bargain.” Buying a declining stock makes you feel like you are getting something on sale. This very rarely works. A stock is down typically for reasons you should avoid it. For example, in late 1999, a client bought Xerox when it dropped abruptly to a new low at $34 per share and seemed really cheap. A year later, it traded at $6 per share. Why try to catch a falling knife? Many people did the same thing in 2000, buying Cisco Systems at $50 on the way down after it had been at $82. It never saw $50 again, even in the 2003 to 2007 bull market. In fact in June of 2010 you could buy it for $21 per share.
#3: Not understanding the true direction of the overall market and recognizing when a market decline is most likely or a new uptrend is confirmed.
It’s critical that you be able to recognize market tops and major market turnarounds coming off the bottom if you want to protect your account from excessive giveback of profits and significant losses. Likewise, you must know when the correction is over and the market tells you to buy. You can’t go by your opinions or feelings. You must have specific rules and follow them religiously.
#4: Letting your emotions drive your decisions rather than following your buy and sell rules.
Never become emotional about the stock market. The soundest rules you create are of no help if you don’t develop the discipline to make decisions and act according to you historically proven rules and game plan.
#5: Concentrating your effort on what to buy and, once the buy decision is made, forgetting to manage your position.
Most investors have no rules or plan for selling stocks once they buy.
#6: Failing to understand the importance of buying high-quality companies with good institutional sponsorship.
Always pay attention to what the pros are buying. They are the ones that buy enough shares to move a stock. Make sure you are on the right side of the institutional market.
#7: Buying on tips, rumors, split announcements, and other news events; stories; advisory-service recommendations; or opinions you hear from other people or from supposed market experts on TV.
Do your research. There is no easy way out. Many people are too willing to risk their hard-earned money on the basis of what someone else says, rather than taking the time to study, learn, and know for sure what they’re doing. As a result, they risk losing a lot of money. Most rumors and tips you hear simply aren’t true. Even if they are true, in many cases it is already priced into the stock and when the event actually takes place, the stock concerned will ironically go down, not up as you assume.
#8: Wanting to make a quick and easy buck.
Again, I saw this mistake made by almost every single client. Wanting too much, too fast without doing the necessary preparation, learning the soundest methods, or acquiring the essential skills and discipline to be a successful investor. Chances are, you’ll jump into a stock too fast and then be to slow to cut your losses when you are wrong.
#9: Buying old names you’re familiar with.
Just because you used to work for General Motors doesn’t necessarily make it a good stock to buy. As I was a broker in the Detroit area, I had a number of General Motors employees as clients. It was like pulling teeth to get them to part with that stock. Very few actually would. Well their emotions got in
the way and most never saw GM was headed in the wrong direction. As a result they watched their life saving get destroyed as GM went into bankruptcy. Remember, many of the best investments will be newer names that you won’t know, but that, with a little research, you could discover and profit from before they become household names. Did you recognize the name Google ten years ago?
#10: Not being able to recognize (and follow) good information and advice.
Friends, relatives, certain stockbrokers, and advisory services can all be sources of bad advice. Only a small minority of people giving advice are successful enough themselves to merit your consideration. Outstanding stockbrokers or advisory services are no more plentiful than outstanding doctors, lawyers, or ballplayers. Only one out of nine baseball players who sign professional contracts ever make it to the big leagues. Most of the ballplayers coming out of college simply are not professional caliber. Many brokerage firms have gone out of business because they couldn’t mange their own money wisely. Look what happened to Merrill Lynch. They had to be bailed out by Bank of America due to poor investments and leverage. Better yet, look how many people blindly trusted Bernie Madoff and lost everything. You have to do your own homework. Trust no one blindly.
#11: Speculating too heavily in options or futures because you see them as a way to get rich quick.
Some investors also focus mainly on shorter-term, lower-priced options that involve greater volatility and risk. The limited time period works against holders of short-term options. Some people also write “naked options” (selling options on stocks they do not even own), which amounts to taking greater risk for a potentially small reward. Make sure you completely understand how options or futures work prior to delving into this world. It’s very complex. I’ve seen too many investors loose it all because they don’t truly understand what they are getting into.
How many of these describe your own past investment beliefs and practices? Poor principles and methods yield poor results; sound principles and methods yield sound results. As knute Rockne says, “Build up your weaknesses until they become your strong points.” It takes effort and time to properly arm yourself with knowledge. Trust no one. Take the time to become a great investor. Learn from your mistakes. That is the only way you will become a great investor.
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