Serious investors who want to make money from investing in the stock market often pick up some books written by or written about investment experts or gurus such as Warren Buffett and Peter Lynch.
The lessons learnt from investment legends will definitely help one to avoid some of the common investment mistakes. So, learning the right investment tactics and strategies is definitely a shortcut to successful investment.
Other than acquiring the right investment approaches from the masters, one can also study the common mistakes made by other investors, especially retail investors. After learning the types of mistakes commonly made by other investors and why they continue to lose money, we can avoid these mistakes so that we do not fall into the same traps again. Perhaps we can even adopt a completely different strategy in order to make money.
A reluctance to cut losses
The single biggest mistake of local investors is their reluctance to take losses. This is not unique among local investors. In fact, this phenomenon also happens in other countries, including developed market like the US where investors are believed to be more savvy than those in emerging markets. People have a tendency to feel more pain when taking a loss. Research shows that the quantum of pain from suffering a 30% loss is about 2.5 times more than the joy from making a 30% gain. To avoid the pain, investors tend to keep loss-making stocks year after year. So long as the loss-making stocks are not sold, the pain is not felt.
It is not uncommon to see an investor having a long list of loss-making, poorer quality stocks in his or her Malaysian Central Depository (MCD) statement. The excuse given by investors for not selling these stocks is that they are waiting for the stock to recover. Psychologically, it is believed that so, long as a loss-making stock is not sold, there is still hope that one day the price may recover, but if the stock is sold, the loss is realised.
It is normal to hear that “I am stuck with the stock due to losses”, “how can I sell now, the price is lower than my cost”, “I can’t do anything now as the price has gone down.” As the market does not set traps for punters, it is the punters who voluntarily tie themselves up by refusing to get out of a sticky situation. Stocks do not recognise who gets “stuck” with losses, neither do they feel sympathy for loyal punters who endure financial pain.
For whatever reason, when a loss-making stock is purchased, the only rationale to continue holding on to the stock is hope. Most of the time there is no specific fundamental reason nor news to justify holding the stock. Hope is a bad reason for holding a stock as its fate often purely determined by chance.
Unfortunately, the problem with some of these poor-quality stocks is that if their fundamentals continue to deteriorate, these stocks may fall into PN17 status or be eventually delisted. By then, it will be almost impossible to recover whatever amount invested in the stocks. An 80% deterioration in price can end up as a 100% loss when the final nail is hammered into the coffin.
Quick to take profit
Another reason why a typical investor has a long list of loss-making third liners and little in quality stocks or blue chips in his or her MCD statement is that most of those stocks that made money have been sold. As the probability of making money from investing in quality stocks and blue chips is higher, investors are quick to lock in profit and proclaim a triumphant victory.
Over time, good stocks are sold and poorer-grade stocks are kept in the portfolio. Unknowingly, investors sell the valuables and became collectors of “rubbish”.
It is also common to hear “advice” from fellow investors that one should not be too greedy. If a stock appreciates by 20%, common advice is to lock in the profit before the price comes down. It is not entirely wrong to take profit. But what if the stock price falls by 20%? Should there not be a similar strategy to protect a portfolio when the stock price turns south? Investors make several mistakes by taking early profit:
• Taking profit early should apply to trading stocks and not on investment-grade stocks;
• Investors should also set a cut-loss strategy instead of only a profit-taking strategy;
• Instead of selling quality stocks and keeping speculative stocks, investors should sell speculative stocks acquired based on rumours and keep quality stocks.
Preferring cheap stocks
When it comes to the level of stock price, the common perception is that a RM1 stock is cheaper than a RM10 stock. It may sound logical but it is entirely wrong based on the fundamentals of investment. From an investment approach, a stock is purchased because of its future earnings outlook. As such, a RM1 stock having negligible earnings is more “expensive” than a RM10 stock yielding RM1 profit per share.
Perhaps a RM1 stock is perceived as easier to be “pushed” by syndicates or easier to move up than a heavyweight. Low-priced stocks are generally considered as retail stocks as they normally lack fundamentals and are not popular among institutional investors. Without the help of so-called syndicates, low-priced stocks are traded among retail investors themselves from the same pool of money.
There is no fresh money to lift the stock price higher. This is unlike investment-grade stocks, where improved fundamentals attract more money including foreign funds, resulting in more demand than supply. Hence, investment-grade stocks benefit from the strong price support, leading to a continuous price appreciation over time.
By the same token, when a company announces a share bonus issue or split, which leads to a lower price level, it is welcomed by retail investors. On the other hand, when a company calls for a share consolidation the stock price will plunge. Stock consolidation can be due to the changing of par value from, say, RM0.20 to RM1 or due to capital reduction.
When our market was less mature, there were many retail investors who invested based on market rumours and speculation. Now, there are fewer retail investors participating in the local market and syndicates are also less visible. The strategy of relying on trading penny stocks has not brought much reward in recent years. Although there may be some penny stocks which turn into a five-bagger or even a 10-bagger, such incidences are few and far between.
Changing the goal posts
Another common mistake is the lack of a clear investment goal and strategy, whereby investment stocks and trading stocks are mixed together. As these stocks have different characteristics, they should be treated separately in terms of investment strategy.
A trading stock is normally purchased on a piece of news or rumour which may or may not happen. An investment-grade stock, on the other hand, is normally purchased based on fundamental reasons such as earnings outlook, business potential, and growth prospects.
As a trading stock is more speculative in nature, it should be monitored based on the reliability of the source of information. Technical charts are more useful in helping one on timing decisions to sell, hold or buy further.
Sometimes, investors know they are speculating on a stock but when the stock is out-of-the-money (in a loss-making position), they tend to keep the stock as if it is an investment-grade stock. A punt on a trading stock for short-term gain with a timeframe of several months may end up as long-term hold for several years. The initial objective to make some quick gains by speculating on a piece of news or rumour may end up in the hope that the stock price will recover to its cost.
On the other hand, some investors buy an investment-grade stock for long-term investment due to its strong fundamentals or dividends. But when the price starts to show gain, some investors are quick to take profit for fear that the price may come down. The irony is that a long-term investment now becomes a short-term trade when early profit is seen.
So long as investors keep changing their goal posts and confuse themselves between trading and investment stocks, between short-term speculation and long-term investment, their equity investments will be in a mess.
Excited by tips
Many retail investors are still fond of relying on tips to make money from the stock market. Many who depend on tips lose so much that they simply leave the market and vow that they will never touch the stock market again. Trading based on tips may be exciting, but experienced investors will confess that it is difficult to make money purely on tips.
What are tips? Tips could be insider news from those who know what is going to happen. Insiders could be company directors and senior management, professionals like corporate lawyers, auditors and bankers who may have some inside information or even reporters, analysts, fund managers and individuals who have access to the senior management of companies.
Tips that something is brewing could be true, some may be pure speculation but there are also some which are fabricated by syndicates as part of their games. Most of the time when a punter obtains a tip, it is not first-hand information. The tip could have been passed down from several people. In such a case, even if there are changes to the information, punters will be the last to find out. After the share price has plunged, will they only then realise that things have gone sour. By then it would be too late to sell and the stock may be added into their long list of “collector’s items”.
Little homework
Most retail investors do little homework before investing. Even if they do, it is normally very superficial. There is also little follow-up on the subsequent changes to the fundamentals. Many retail investors give the excuse that the accounts are too complicated to understand. If someone like an analyst has analysed a stock and recommended a buy, the investors will probably rely on the call to make their bet. Recommendations appearing in newspapers are also one of the main sources of investment ideas.
A lack of patience
Another common weakness of retail investors is their impatience. Most of them want quick gains. After they buy a stock due to a recommendation or a tip, they will monitor the stock movement closely. If the stock price moves up, they will praise the person who recommends the stock. But if the stock does not move after several weeks, they will become impatient and keep asking when the stock will move.
Most retail investors are not too keen to invest in a stock that makes 10% per year. They are excited with highly volatile stocks or high beta stocks that can potentially double in value or gain 20% within a week or two.
Always buy higher, sell higher
Because retail investors have little patience, they are not keen to buy on market weakness and wait for the market to recover. The tendency to chase a stock is common among retail investors. As they want to make quick money, they prefer to buy high and try to sell higher, a strategy more aptly applied in a bull market. This phenomenon clearly explains why more retail investors appear during a bull market but vanish at the bottom of the market when prices are much cheaper.
The strategy of buy-high-sell-higher is definitely riskier than the buy-low-sell-high strategy. The former is not inappropriate, but investors must get out of the market if they are wrong. Unfortunately, cutting losses is too painful for most people and many retail investors eventually get “caught” again.
The lessons
There are many lessons we can learn from the mistakes of retail investors, some of whom could be someone close to you — one of your family members, colleagues, friends or even yourself. To be a successful investor with an aim to increase wealth, we need to overcome some common human weaknesses.
At the top of the list, one has to learn to be impartial and view a stock objectively. If a mistake is made, the best thing to do is to take the losses and cut the stock. And it should be done without hesitation. If necessary, a short time frame should be given to try to sell at a slightly higher price. After the time frame, the loss-making stock must still be axed. If you do not have the discipline to take losses, then trading is not for you.
Investors should be clear about the investment plan when investing. Buy-and-hold investment stocks should be segregated from buy-and-sell trading stocks. As the two types of stocks have different characteristics, they should be treated separately with different strategies. The worst mistake is to buy a short-term trading stock and eventually keep it as long-term investment stock. In general, investors should learn to cut their losses and let the profits on investment-grade stocks run instead of selling all the good stocks and accumulateing speculative trading stocks in their portfolio.
Investors who like to dabble on tips should always remember that speculative stocks are trading stocks and certain time frames should be given for the “tips” to work, otherwise the stocks should be discarded, even at a loss. This is the nature of the game. The bet is either you win or you lose.
Ang Kok Heng has 20 years of experience in research and investment. He is currently the chief investment officer of Phillip Capital Management Sdn Bhd.
