Before I start I want to thank the “baglady” for choosing my article on “practical reasons why you should learn a foreign language” to be first on this week’s carnival of personal finance. I apologize for the delay in posts. This week has been hectic. And now, without further delays my post on 10 sure ways to lose 50% of your investment.
#1 Have you heard of technical analysis? I’ve read this book and I’m really cashing in
Technical analysis is a method of using data on a financial asset’s past behavior to foresee future trends. Technical analysis has always been regarded suspiciously by academic scholars yet attracted a huge crowd of supporters amongst investors and traders.
In academic papers stocks are usually assumed to follow a pattern of “random walk”, meaning past price behavior can teach us nothing on the future. However, as markets are not perfect (read more on stock market efficiency) there is reason to believe technical analysis can present more information before reaching an investment decisions.
The important point here is that technical analysis, or any other investment or trading technique, can and should not be used alone as sole parameters for decisions. Regardless, technical analysis is very complicated and requires a deep understanding of statistics and sometimes finance.
#2 That analyst really knows his stuff. I’m going to act on his recommendations
Acting on analyst recommendations can cost you big time. Many analysts are amateurs. Others have conflicting interests and are selling what their investment bank just offered. Some are excellent. Can you tell who is who? As technical analysis analyst recommendations can be factored in a decision. They should not the only consideration to investing (more on analyst recommendations here)
#3 That stock can’t get any lower than that…
Buying a stock just because it has fallen sharply is a big mistake. The saying “don’t try to catch a falling knife” has turned out to be true many times. Sometimes, stock fall for no apparent good reason. However, we don’t have all the information which is often available to bigger investors who certainly know what they are doing when they’re selling that stock. Buying stocks which are traded at very low levels can prove profitable but this technique is often complimented by fundamental analysis and diversification.
#4 I think the (pick emerging market) stock exchange has a lot of potential
Emerging markets hold great potential. That is a fact. However, they hold great risk as well. And that’s another fact we don’t always pay attention to. A military coup, outrageous inflation, communist parties, lack of information, lack of transparency and what not are all very dangerous to investors. That’s why recommendations for investing in emerging market are usually at 8%-10% of your portfolio and diversified to at least 3-4 countries.
#5 If I hang on for just a bit more I’ll regain what I’ve lost
Holding on to losing stocks is a very human thing to do. We get attached to stocks and companies and refuse to let go even if contradicting facts get thrown in our faces. Set a limit. Sell. Don’t hang on desperately. There are many other opportunities just waiting for you to invest in them (wisely).
#6 I heard you can make 1,000% returns on investments in derivatives
The attraction of derivatives, mainly options and futures, are understandable. People enjoy a weekend in Vegas. If you’re gambling your money in derivatives instead of the roulette table everything’s good and you even save the plane ticket. However, if you consider yourself an investor use derivatives only to hedge and insure you portfolio. If you don’t know what that means you should be anywhere near these financial assets.
#7 I can’t make any serious money with diversification. I’m going to put all my eggs in one basket and watch it like a hawk
A common tip by investment gurus is to stock pick and avoid diversification if we want to get richer. Sadly, less than 0.000001% of the population has a proven ability to do that. If you like the odds go ahead. If you’re investing for retirement or college please diversify your portfolio (read more on diversification of risk in the stock market).
#8 Day trading is the life for me
I can just picture it know. Getting up late, staying in my pajamas, and slowly turning on the computer with a hot cup of coffee in my hand. That’s the life. Or is it? 90-95% of day traders lose (I believe the real numbers are much bigger).
Think about it. If it’s so easy (or even possible) why doesn’t everyone do it?
Do yourself a favor. Get a job.
#9 My friends are telling me clean-tech is the next hot sector
I don’t know if you’ve ever noticed but usually we follow trends not start them. If you could start a trend then you just might be able to can make a nice return on investment. Following one, however, insures everyone else will make a nice return on investment thanks to you.
There is a very good chance that if we hear of a trend market prices already reflect the information and there is not much to gain by investing in that particular trend.
#10 I’m a solid guy. I’m at ease only when my money is safely in my bank account
I had to finish with this one. Not investing your money (wisely) is one of the surest ways to lose in the long. You won’t lose your capital but you will lose potential return on investment. How do we invest wisely? A future post will try to answer this challenging question.