Friday, March 13, 2009

Top 10 Stock Trading Mistakes

I've been aggressively trading the market since the advent of electronic trading in the 80's. I've made more than my share of mistakes and have witnessed these from amateur investors much too often, more so than good techniques. In today's market, you have to be flexible and move fast, or you won't be trading very long.

The most common 10 mistakes amateur investors make:

1. Buy and Hold - this simply does not work any more, even if you're going to hold a decade or longer. Some stocks have returned to 1930 levels recently, like Ford, GM, and GE.

2. Holding Losers Too Long - even pros have losing trades; the best attitude is that the 'first loss is the smallest' and to go ahead and take a loss when you're getting uncomfortable with it, say 5-10%. This can be done automatically with a stop loss order placed as soon as you buy a stock that will cause it to be sold if it falls a certain amount. Through experience I like a 5% stop, but 10% for some of the new ETFs.

3. Buying Too Many Stocks - most people hear that they need to diversify, then proceed to buy 10-25 stocks 'to be safe'. The best way to diversify is to buy an exchange traded fund (ETF) that represents a basket of stocks and you have instant diversification. I've found the best amount of stocks to own is 3-10, only a few in bear or difficult markets, and only 10 in raging bull markets. As long as some of these are ETFs, you're diversified.

4. Buying with Market Orders - learn how to use and buy with limit orders, or a top limit that you will pay for a stock. Otherwise, you may be the chump that bought at the high of the day just after the market opens when a market-maker takes advantage of your order. I've seen prices jump from 15 to 18 for one order, then come back down to 15 again!

5. Buying Stocks at the Open - the first half-hour to hour of market trading is the worst time in the day to buy stocks. Orders pile up overnight from people who trade after work, from Asians, then Europeans. So when the market is in a rally, these are usually buy orders and the market often opens higher, then dips after these initial orders are processed. It's best to buy after the first hour or during the lunch hour. It's said that 'amateurs trade the open, pros trade the close'.

6. Buying Hot Tips - rarely will you hear the proverbial 'hot tip' that turns into one. What you'll hear more often is unsubstantiated rumors, bogus stories, sometimes downright fraudulent attempts to move a stock. Always fully research these stocks before buying them, and get opinions from numerous sources. There have even been scams online where people faked valid news agency articles about a stock, causing rapid price movement and prison!

7. Buying Companies You Like - most people like Apple stock because they like iPods or iPhones, Disney because they like the movies, or Wal-Mart stock because they like cheap goods; all would have lost money for recent investors, some for a whole decade. Often by the time the public buys a stock, the easy money has been made by the pros and insiders, and the public is left 'holding the bag'. It's better to buy less-known companies that market pros like.

8. Buying Stocks That Analysts Like - this is also often bogus information you're hearing. Analysts quite often are simply 'talking their book', they want the public to buy a stock so they can sell out at higher prices. They may also want to drive a price down to buy in at lower prices - you can never really ascertain their motivation, so be skeptical.

9. Averaging Down if a Stock Falls - this is buying more of a stock as it falls, and 'averaging down your break even price per share'. Its awfully tempting if its a good company; the price will come back, won't it? So you double up and now have twice as much money at risk in a falling stock. After the stock falls 50-90% you have multiplied your original loss, and pros call this 'throwing good money after bad'. It's the equivalent of doubling up your bets in Vegas until you finally win! Average up, but never down, as a stock that falls 50% from 100 to 50 now has to go up 100% to get back to 'even'.

10. Buying Cheap Stocks - many think they can buy a penny stock that goes to a dollar and they make several thousand percent on this trade, which will pay for many losers. This is their confidence game, the lure of 'lottery winners', but it's a losers' game. Over a decade, 80% of all public stocks will go bankrupt, and guess where the majority are in price? Yep, under a dollar, which is where they have to fall before going to zero. Cheap does not often mean 'bargain' in the stock market.

There are probably hundreds of other valid tips available for both investors or traders, and I'll include more here. The important factor for all is preservation of capital, or you won't have anything to invest, so keep your losses minimal and you're on the way to stock market profits.

"Return of principal is more important than return on principal." - Will Rogers


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