Avoid Investment Mistakes: Common Pitfalls to Watch Out For

When it comes to investing, there is no formula to success. There are many different profitable investment styles, thus we cannot say “just do X, Y, Z and you’ll be a millionaire”. However, we do know what doesn’t work – we know which investment styles / strategies lead to failure. So the joke here is that once you’ve discovered everything that doesn’t work (aka lost quite a bit of money), you’ll know what does work.

To help make your investment education less expensive, I’m going to share with you 4 mistakes that will make you lose money in the stock markets (or bond, currency, and commodity markets for that matter).

1. You’re Chasing Great Returns

This is a mistake that applies not only to investing but to life in general. You see, I wake up everyday with one thought on my mind: “I want to be great”. And for me, “being great” doesn’t just involve a few congratulations from those around me. Words are cheap while action talks. So ever since I was a little kid, I always pushed myself as hard as I could in order to WIN. Cross country race? I’d always try to push my stamina limits to the max. Math competition? I’d better get first place.

During one of the parent-teacher interviews, my Gr. 3 teacher said to my parents “your son tries so hard that he loses himself”. And you know what? He was absolutely right! Sometimes, just the psychological burden of “I have to win first place” or “I have to achieve greatness” is so heavy that it actually prevents us from achieving greatness. Putting so much stress on ourselves only makes things harder.

The same concept applies to investing. Do not aim for great investment returns – aim for good investment returns. So instead of aiming to make 25% a year, be content with 15% a year. And you know what the funny thing is? When you set your goals at a reasonable expectation (aka good returns), you’ll often end up achieving great investment returns!

There are stories everywhere of highly successful investors and traders repeating this idea. Here’s an example. Michael Steindhardt (now retired) was a legendary fund manager back in the day. Towards November of 1991, his fund was up 26% for the year. Of course, he wasn’t content with this “good” returns, and he kept trying to finish the year with a 30% returns (4% higher than where he already was). So he kept trying harder and harder and harder. By year’s end, he was up 23%!!! In other words, his “I want to be great” mentality was actually a burden and cost him 3%!

2. You’re Trying to Beat the Pros at their Own Game

When times are flush (aka the stock market is going up up up), people start thinking “investing is easy!” Of course investing is easy – you don’t have to think! In a bull market, you just buy and watch stocks go up! In other words, it’s not your skill that’s yielding these profits – it’s the times! So they start trading, and that’s when disaster starts to hit. At first they make a decent amount of profits trading – of course, in a bull market everything you buy goes up.

But what happens when the bull market turns into a bear market? Essentially, these newbie traders really have no idea what they’re doing. So they get taken to the cleaners and lose the majority of their investment (trading) portfolio. The reason for this is simple. There are guys who have been trading their whole lives – the pros. Can you – the newbie trader – really beat the pros at their own game? I haven’t heard of a field where the newbies beat the old, battle hardened pros. Experience is valuable, inexperience is deadly.

So the lesson is, stick to investing. Just because times are flush doesn’t mean that you can trade profitably and consistently.

3. Don’t Chase the Market

I was watching a show on YouTube the other day (Little Mosque on the Prairie – funny stuff – check it out). This show captured the perfect essence of what most investors do in a stock market bubble. So in the show, there were 4 people. The small shop owner, the electrician, the teacher, and the doctor. Basically, the point was that the small shop owner is the “dumbest” in terms of IQ and the doctor is the “smartest”. So in the stock market bubble, the small shop owner buys stocks first, because she is easiest to be fooled into thinking that the “bubble will go on forever”. Then, the electrician buys stocks, and after a while, the teacher does too. All along, the doctor has been calling this bubble “insanely irrational”. But seeing that the stock market goes up day after day, the doctor finally chases the market and happens to buy stocks exactly at the bull market peak.

What’s the lesson of this story (besides the fact that people with a higher IQ aren’t necessarily smarter)? If you missed out on the bull market, don’t go chasing after it. People who’ve missed out often say “I’ll buy back in on the dip.” But the market doesn’t dip, and it goes higher and higher and higher. And finally, when the market does dip, it’s not only a dip. It’s the beginning of an avalanche of selling.

4. Trend Following in a Whipsaw Market

Most investors are trend followers. When the stock market starts going up, they buy. When the stock market starts going down, they sell. Now this strategy is OK as long as you get in early enough. However, this strategy is disastrous in a whipsaw market. Historically speaking, there have been years when the stock market has gone nowhere with heavy volatility (huge swings in price). In a market stage like this, trend followers get their a**es handed to them. When the market starts moving in one direction, trend followers follow suit, but then the market reverses course and the trend followers have a big fat loss on their plate.

The point is, remember that trend following (which is the investment style 99% of investors use) doesn’t work all the time. It only works when there are trends. And here’s a little hint. I think this year (2014) we’re going to experience some pretty intense swings in price. This isn’t going to be 2013 all over again when the stock market keeps going up up and away.

Thanks for reading! I’m Troy, and I write about Ghost in my spare time. Any comments, questions or concerns – just comment below!