This is an article I’ve been wanting to write for a long time. As more new investors are starting to take interest in stocks this year, I see this as timely. This will be a sort of companion article to Episode 2 of The Dividend Magic Show.
A list of all the videos and episodes of the Dividend Magic Show can be found hERE.
I’ve been investing for a few years and made a few mistakes along the way. Thankfully, although painful, these were mistakes that I was able to recover and learn from.
Which brings us to the main objective of this piece – I sincerely hope all of you reading will be able to avoid all (or some) of these pitfalls
Mistake 1: Timing the Market
To make this easier to relate to, I’ll be basing these mistakes off my good friend Alan.
Let’s start off with Alan first venturing into stock investing. He has had his eyes on a stock for the longest time. With cash on hand and ready to buy. He feels that the price right now is a tad high and wants to wait it out.
So he continues checking in with the stock every day, but to his dismay, the stock just keeps going higher. And at the end of the day, Alan is still holding on to his money and he has yet to make an investment.
So this right here is when one metaphorically misses the boat. It is one of the consequences of trying to time the market and hoping to buy at a stock’s lowest point or sell at its highest.
You’ll more than likely not be able to time it right, instead an investor should have his/her own target price after their own research is done. And based on this price, an investor will be able to decide if it is the time to buy or sell a stock.
Another strategy to manage this type of situation is allocation. Let’s say a particular stock is within my target price. And I have allocated RM5,000 for this stock. I will first put in and purchase 30-50%. And then if the stock price drops further, I will purchase the remaining amount to average down. But if the price goes higher, I will be content with the profit I’ve already earned.
Mistake 2: Chasing High
Back to Alan. So now that Alan sees the prices going up, he experiences a fear of missing out (FOMO). Thinking ”What could go wrong? Prices are going up, I don’t want to miss this boat”, he buys into the stock hoping for prices to go up even further.
What usually happens at this point is that in the next few days, prices will retrace and Alan is caught at a high.
And here comes the next mistake which is what we term “chasing high”. I do notice that a lot of investors like to buy in when the stock is hot and trading up. Reasons for hot stocks can be many, but most commonly, we see Malaysian investors buying on news and rumors.
Most of the time when the price goes up, it attracts investors’ attention and hence a lot of people will buy, hoping that the price will continue to increase. However, it is very common that they will find themselves trapped at these prices when the stock price retraces.
We need to understand that if the stock goes up at a rapid pace, there is bound to be some price retrace, or the price will stabilize within a trading range.
Mistake 3: No Due Diligence
Now Alan who was afraid of missing the boat and bought at a high price, faces a retrace. He is probably looking at a paper loss of 5-10%. In Alan’s mind, he will want to buy more units of the same stock to average down.
And as the stock price keeps going down, naturally Alan will start to panic. He scrambles around to look for the company’s annual and quarterly reports. He starts calling up friends and acquaintances looking for advice as they initially recommended this stock to him.
Multiple real-life occurrences here. First, this one is very real where a person is investing based on someone else’s recommendations. On top of that, Alan appears to have zero understanding of the stock he is investing in in the first place. I’ve always emphasized and urged readers to always, always do their own due diligence. No matter how convincing a person is when recommending a stock to invest in, you should always do your own homework first.
Say, for example, one is looking to make a big purchase. A house or a car. Naturally, you’d make sure to shop around, do your research, check every detail before making said purchase. So why should our stock purchases be any different? So, always, always do your own due diligence.
Mistake 4: Benchmarking on Past Performance
So back to Alan again. A few weeks have gone by, he has now accumulated a bigger, let’s say 20% loss as the stock continues its retrace. Alan has finally taken the time and had a good look at the company’s reports. The company has been doing great for the last few years, paying consistent dividends. So Alan thinks to himself, if they can do it then, they could do it now right?
So right here, Alan is potentially stepping onto a minefield. As the saying goes, past performance does not always indicate future growth. While a company’s past and history can provide us a certain benchmark and understanding of the company, we should also incorporate critical thinking into our analysis.
First, we should always make sure that the company is still functioning and doing business as it always has been. We then need to make sure that there is still room for the business to grow and that they have not peaked and plateaued. Competition is also a huge factor unless there are high barriers to entry. So these are the few things to look at, we will go deeper into this in our coming videos as we talk about individual stocks.
This is also true for dividend investing. Past dividend yields will never guarantee you future yields. You might be looking at a company that’s paying very high yields based on its past payouts. But in fact, the price has actually gone down, pushing up the yield %. Many are attracted by the yields when prices drop. But the said companies are actually unable to payout the same dividends as last year. So make sure that you as an investor do not only look at a company’s past.
Mistake 5: Emotional trading
Now that Alan’s holding is constantly bleeding, we can imagine him being both sad and possibly angry and confused at the same time. His next step is to then recklessly average down, hoping to push his average buying price down so the moment the stock rebounds, he can sell it off for a profit. As days go by, the stock hardly moves and stays stagnant. Until one day Alan realizes that he is in fact looking at a huge potential loss.
Now, we say potential loss because Alan hasn’t actually closed off his position. I see this as a loss already because of opportunity cost. This money and capital could’ve been invested elsewhere, earning returns. So the loss is actually two-fold. The loss itself, and the opportunity cost of not investing that money into something else.
So, never ever involve emotions when it comes to investing. Stick to your research and trust the numbers. If a company’s stock prices continue to plummet, you either realize that a mistake has been made, and cut your losses or, if the company’s fundamentals are still intact, hold it out. Or, continue adding to your position.
The reason why we are sharing this is that in the past few months, the stock market (especially KLSE) has seen a lot of speculative trading. An influx of new investors who buy base on recommendations, news and rumours. Some of you may have been lucky and made a profit. Some of you may have not been so lucky and are in the red. If you’re looking to invest in the long term, please do consider the mistakes above and try to avoid them.
Remember to always:
- Make sure to do your due diligence, understand the business thoroughly before you invest.
- If you are unsure of the price trend, you can always allocate 30-50% of your funds first.
- Always have a plan in mind. If you are holding a stock for the short to mid-term, remember to set a target price for yourself to sell the stock. If it hits the target price, stay disciplined, and sell it off. Never try to time the market and hope to buy at the lowest, sell at the highest.
- Don’t let your emotions affect you. This usually happens if someone has a huge % of their portfolio in one single stock. So when the price goes down, it will lead to bad decisions or worse it will affect your daily life. Always remember to diversify.
This article is written as an accompanying piece to Episode 2 of The Dividend Magic Show.
I’m sure there are lots of other mistakes not mentioned here, leave a comment on some on the worst mistakes financially you’ve done while investing in stocks.