What are the most common reasons why many investors end up losing money in the stock market? More importantly, what can we do to prevent this from happening?
Here are three of the biggest reasons why people lose money in the stock market:
#1: Incorrectly equate price with value. The price of a stock is what you paid. The value is what you get behind the business. Mr. Market can vary the current price of a stock. This does not change the intrinsic value of the business in generating free cash for its shareholders and consistent profitability in the future. You increase your chances of losing money in the stock market when you do not take the time to assess if the business is best of breed in its industry or sector.
This means that you should spend a little time:1. checking out the most important growth rates to assess profitability, 2. verifying if the business has an economic advantage over its competition, 3. ensuring that the management team is working for the shareholders and not ripping them off,4. determining the intrinsic or fair market value of the business, and5. purchasing the business with a margin of safety by buying it when it comes on sale.
Should you like a step-by-step approach to assess whether a business is best of breed or not, visit Stock Investing Simplified.
#2: Letting emotions get the better of you.Rather than using a rational approach and sound reasoning to guide your decision-making process, you may get caught up in the hype surrounding the market. You end up buying when the stock is over-valued and selling pre-maturely, when the media is calling for the end of the world.
Panic and greed can set in, clouding one's judgment in making sound investment decisions.
Avoid getting swayed by the masses by looking for any significant changes in the company's fundamentals, emerging competition and market trends. If everything checks out, then in all likelihood you are better off being patient and waiting.
This leads us to the 3rd most common reason why people lose money in the markets.
#3: Lack of patience.Very often we see investors moving in and out of the market without allowing adequate time for Mr. Market to price the stock at its intrinsic value or fair market price.
You may find that you are easily influenced by the media and stock investment industry hype and move in and out of positions by trading, always looking for the quick buck rather than being patient.
This creates, more often than not, a scenario where you end up selling when you should be buying. As a general rule of thumb you would be better served if you sold what is doing the best and buy what is doing the worst in a hyped market.
Heed this advice no matter whether you are talking about stocks, bonds, real estate or commodities. If you have done your due diligence and verified that you are dealing with the best of breed in that class, then using a contrarian approach to what the panicked masses are doing can present some profitable opportunities.
In summary, base your investment decisions on the sound selection of best of breed businesses using a rational and patient approach to greater profitability.