It has taken me years to gather the most common mistakes people make when investing in the stock market, the ones we should avoid. And despite what many may think, as you gain experience in stock market investing, it isn’t that you make fewer mistakes; we actually tend to make even more.
This is mainly because the stock market has more to do with psychology than with numbers. We can control everything related to the investment itself, but controlling our own mind and emotions is harder.
Still, there are investing mistakes for every level and taste.
All the mistakes we make when investing in the stock market
1. Not understanding, or distorting, what investing in the stock market means
This is possibly the most common mistake, and it basically leads us into the world of stock market investing as a mere form of speculation. For a moment we forget the most useful part of the stock market, which is financing companies and providing liquidity to the market. We forget about becoming shareholders in a company in order to be part of it, and yes, of course, to make money from that investment.
If the best investors in history have one thing in common, it’s that they were business people before they were investors, and so they thought like business people when they invested.
When was the last time you invested in a listed company because you wanted to be part of its business, and not just because you wanted to buy in order to sell and pocket a quick profit? This distorted idea of investing is what leads us to set aside the long term, which turns out to be the safest and most profitable approach, and focus on the short term, which is what leads a high percentage of stock market speculators to lose money again and again. And that brings us to the next mistake.
2. Starting with trading instead of value investing
Hundreds of ads bombard us every day with the idea of making lots of money every day by trading. The problem is that those ads are selling hot air. Since it’s a subject we’ve covered many times, I’ll sum it up again: 90% of traders lose money year after year, while 90% of investors who invest in a diversified way with a 10-year horizon make money. The statistics are against trading and in favour of the long term.
Funnily enough, the traders who make the most money, the millionaire traders, are rich not because they trade, but because they make their money teaching thousands of traders to try to achieve what they themselves never achieved.
We shouldn’t forget that trading is no longer a zero-sum game where one investor wins because another loses. These days, trading is a game in which you compete against an algorithmic system designed for you to lose. And very few traders beat the machine.
3. Borrowing money to invest
However sure you are that it’s a good time to invest in the market, or however sure you are that your skill at making money by speculating in shares is incredible, you should never borrow money for that purpose. In the stock market there are never any guarantees that everything will go well. In fact, the most sensible advice for anyone who wants to invest in the stock market is to invest money they don’t need and that, if it came to it, they could even afford to lose.
If you take out a loan to invest, you won’t only be eating into your returns if things go well; if the investment goes wrong, you’ll not only have lost your money, you’ll also be left in debt.
4. Not understanding investing, the investment product or the company’s business
This mistake is about ignorance at any point in the investment. Investing once in the stock market and winning doesn’t make you a genius or an investing legend. At the time of the investment you had a 50% chance of it going well and a 50% chance of it going badly. Nobody becomes a genius by calling a coin toss correctly.
See also: What Warren Buffett never did, and what he always was
Some people decide to get into stock market investing without the slightest idea of how the market works. They’ve simply seen other people make money from investing and make the mistake of thinking they can do the same without having spent the time others have spent studying even the basics of investing.
Others start using investment vehicles they haven’t mastered, such as options, futures, warrants or CFDs, and get a nasty surprise when their investment goes wrong.
See also: The best books on the stock market and finance
And finally, there’s another investing mistake: investing in a company simply because it’s rising a lot, or because it has fallen a lot and is now at a price that analysts say is good. In either case, people decide to invest without knowing anything about the company, without the slightest analysis of it or of its competitors. Any gains from this kind of trading are still pure luck. And luck in investing doesn’t usually last long.
5. Impatience: another big investing mistake
Let’s be realistic. Most people who get into stock market investing don’t want to wait 15 or 20 years for results. They want profits, and they want them now.
Winning stock market strategies come down to profits and reinvesting profits. They come down to investing in companies that pay good dividends and reinvesting those dividends. The most profitable stock market investing relies on the well-known power of compound interest. That’s how great fortunes are made.
As a famous investor once said, good investing is more like watching grass grow. It isn’t fun, it isn’t exciting; it’s something that takes time.
The problem is that many people don’t understand that billionaires didn’t get rich by investing in the stock market, but through their companies or their professional work, putting in money they had earned from other sources of income.
The more capital your work or business generates, the more you’ll be able to invest in the stock market, and the sooner you’ll reach your goals. In other words, before they’re good investors, good investors are good business people, or good at making money by other means.
Remember this: the stock market doesn’t make you rich; it helps you multiply your wealth.
If you’re able to invest a certain amount in the markets every month, you’ll need patience for your investments to bear fruit.
6. Trying to jump onto moving trains
Some listed companies shoot up 15% today and another 30% tomorrow, and we don’t want to miss out on those returns. That’s when another very common mistake appears: jumping onto that moving train, just in time to see it stop and start to correct.
In the stock market, the visionary makes money, those who follow the visionary make money, those who ride the trend make money, but the reckless go to the slaughterhouse.
Before investing in a company or a rising market, always make sure you’re not the reckless one. More than 60% of investors act recklessly, and that’s why the most common mistake investors make is buying at the peak of a rally and selling at the bottom of a fall. In other words, buying and selling at exactly the worst moment.
And this basically happens because, as we said, stock market investing is more about psychology than anything else. We buy out of greed and sell out of panic.
7. The influence of the crowd
We tend to follow the herd. It’s very easy to get carried away by fashionable investments and the companies of the moment. This leads us to invest in cyclical companies or in sectors forming a bubble that’s about to burst. It even leads us to invest in companies that are rising when nobody even knows why.
If successful investors have made one thing crystal clear, it’s that the most profitable approach in stock market investing is to go against the tide. That is, to buy when the crowd is dumping its investments out of panic, and to take profits when the bubble is already too inflated, so as not to watch our investments lose value when it’s in danger of bursting.
See also: The myth of getting rich in the stock market and retiring young
The moment at which we enter the market already goes a long way towards securing not only the success of our investment, but a much higher return. Nobody ever got rich buying high and selling low.
8. The stock market isn’t for you
Why not accept that equity investing isn’t for everyone? If you invest in the stock market and feel uncomfortable every moment, if you need to check on your invested money every hour of the day, or if you can’t sleep because you’ve invested in the stock market, it’s quite likely this kind of investment isn’t for you. Perhaps you’d be more comfortable with a lower return in fixed income.
On the other hand, sometimes the only thing that’s wrong and worrying us is that we’ve invested in a company while making many of the investing mistakes we’re listing here, and deep down we know our investment is badly made. It may also be that we’ve invested money we can’t afford to keep invested for long, or that we’ve invested only because the share price had risen a lot, because everyone was recommending it, or for some other reason.
Investing without any analysis of where we’re putting our money, or without a clear, defined strategy, is also enough to keep us awake at night.
9. Over-diversifying to make the investment safe
Most investors know you shouldn’t put all your eggs in one basket, but we often make the mistake of over-diversifying, filling our portfolio with all kinds of companies and industries, without realising that the high returns from some companies will be eaten up by our other investments in loss-making ones.
Sometimes over-diversification only shows that the investor isn’t ready to invest. What’s more, in many cases it’s worth asking whether we really want to over-diversify, or whether it wouldn’t be better to invest directly in the index following a defined strategy.
10. Not diversifying
Ironically, another common mistake investors make in the stock market is the opposite of the previous one: not diversifying, and putting all our capital into a single stock.
However sure we are about something, we can’t invest all our capital in a single stock, because many things can happen in the stock market. Also, when we talk about diversification we don’t just mean across different stocks and industries, but across different investment products. That is, one percentage of our portfolio in equities and another in fixed income (bonds, deposits…), perhaps investing in gold or some other commodity. At certain times, gold and silver act as insurance to protect your wealth. However, in these cases everything depends on the capital we have available to invest and on other factors that need to be analysed.
11. Investing in the stock market without getting rid of toxic debt
For some reason, some people don’t understand that the best investment there is, is paying off loans and credit with high interest rates working against us. When it comes to toxic debt, you’ll rarely find a safer and more profitable investment than paying it off, because the return is guaranteed.
Anyone with toxic debt shouldn’t start investing until they’ve got rid of it completely.
12. Acting like Warren Buffett is also an investing mistake
Be careful about investing like Warren Buffett, because you should know you’re not Warren Buffett. We know Buffett can stay invested in a company throughout an entire crisis. That is, even if he knows his share portfolio is going to fall 40%, he holds on, because he knows the market will rise again and considers his companies solid.
In fact, Warren Buffett himself says that if you don’t have the stomach to watch your investment fall 50%, you shouldn’t invest. But then… why watch your shares fall 50% if you can avoid the fall? You’re not Buffett, you don’t have Buffett’s annual income, so if you can add more return to your investment, so much the better.
See also: Investing in a business: the most profitable investment
So if you foresee a sharp correction, the start of a recession or something similar, however sure you are that your shares will rise again after the correction, it’s always better to take the opportunity to get your capital out intact, wait for the price to fall further and buy many more shares with the same money, not to mention that, when the time comes, you could even go short on the shares and make money from the fall as well.
Serious mistakes in stock market investing
Along with impatience and borrowing money, there’s another of the most serious mistakes that people new to the stock market tend to make. Being a serious mistake doesn’t mean it isn’t a common one. This mistake is…
13. Investing money in the stock market that isn’t meant for investing
Basically, this means investing money we’ll probably need. If that’s the case, we’re setting ourselves up so that, if our investment goes well, we’ll have to cut a good investment short to take the money out, and worse still, if the company we’ve invested in goes through a temporary correction, we’ll have to take our money out at an irreversible loss.
So we insist once again: we should invest money that, first, we can afford to lose and, second, we at least won’t need for the next 5 or 10 years.
14. Not accepting a loss
Sometimes we get it wrong. That’s all there is to it. Anyone can make a mistake, and you’re no exception. What matters is what you do once you’ve made a mistake, and above all whether or not you’ll recognise it in time.
Many emotional and psychological factors come into play here. Nobody likes losing money, and the stock market has the advantage that a loss isn’t real until you sell at a loss. As long as you don’t sell, you can always hope the stock will recover.
But there are times when it’s more effective to cut a 10% loss than to put your entire investment at risk. And we’ve seen this very often in the stock market: people who had already built up losses of up to 40% on a company, with nothing in its favour, held on without knowing why. All they could say was: “I’m not going to sell at a 40% loss. I’m not going to lose 4,000 euros.” Their reasoning made them lose not 4,000 euros, but everything: 10,000 euros.
15. Selling winners and holding on to losers
Linked to the previous psychological mistake is the inexplicable habit of holding on to companies where we have losses and selling companies that are making us money. The reasoning is clear: I sell the winning companies to take profits before my investment turns, and at the same time I keep the losing companies until they recover.
Experience and statistics say that companies in an uptrend will continue their uptrend, while those in a downtrend will keep falling. In both cases, of course, for as long as the trend lasts. So you should avoid selling companies that are still doing well.
Let the market take you out of the winning companies. That is, set a trailing stop loss that follows the share price and is triggered when the market corrects by the percentage set in the stop loss, not before.
As for the losing companies, perhaps it’s worth going back over point 14 and cutting the loss, depending on the case and on how far the share price has fallen.
Bonus: the mistake of all mistakes, not learning from our mistakes
Every mistake is a lesson, as long as you learn from it. The more money a mistake has cost us, the more expensive the lesson, and therefore the more valuable the learning.
But if you don’t learn from that mistake and make it again, it will all have been a loss. Other investors’ mistakes are also your greatest source of learning. Your first stock market lesson begins the moment you watch what most people who are about to start investing in the stock market do. With the statistics in hand, you know most of them are going to lose money, so it’s as simple as not doing what they’re doing.
Featured image: George Chernilevsky, CC BY-SA 4.0, via Wikimedia Commons.
