Buying Stocks – the 7 Most Common Mistakes

Forms of investments and strategies

Private investors make avoidable mistakes

6 minute read

While purchasing stocks, many private investors make losses through unnecessary mistakes. They often don’t have the necessary knowledge of the stock market or they let themselves be led by their emotions. We will share with you the most common mistakes during the acquisition of shares and how to avoid them.

 

Certain basic knowledge is essential before the purchase of stocks. One of the most common mistakes is to simply start exchanging without any prior knowledge. But he who lacks basic knowledge runs the risk of losing a lot of money on the exchange market. Inexperienced investors tend to pay exaggerated prices for stocks because they don’t know the most important key figures or buy and sell shares at the wrong point in time. Therefore, beginners need an introduction into the world of the stock market before making a purchase: How does the stock market work? How does a share price develop? How do you start a stock portfolio? What is a broker? What is a dividend?  Knowledge of the stock exchange also includes basic knowledge of finance. Anyone who dares to venture onto the exchange floor without the necessary knowledge will quickly become food for stock market professionals.

 

A study by economics professors Andreas Hackethal and Steffen Meyer for the magazine Finanztest concludes that private investors missed out on the big stock market profits between 2005 and 2015. The study examined the stock portfolio of 40,000 direct bank customers. At an average return of 3.1%, these investors were well below the market's annual growth rate of 8.7%. The reason for this was less lack of stock market knowledge than short-term trading and blind actions. Private investors often lack the calmness and serenity to hold on to their company shares even in the event of a falling share price. At the same time, they tend to sell too early in the event of a rising share price. In both cases, they miss valuable opportunities. Instead, investors should pursue a medium- to long-term investment strategy and maintain it even in the event of short-term market turbulence.

 

Diversifying risks is the foundation for success in the purchase of sales. For private investors this means: diversification beats concentration, meaning that risks in a portfolio are mitigated when investing in stocks from various industries. Should one sector experience a crisis, the whole portfolio does not lose worth. Nonetheless, many private investors do not follow this basic rule enough, because they have too many individual shares in their portfolios. The survey for Finanztest showed that direct bank customers have an average of only 12 individual shares in their portfolios – too few to avoid bulk risks. Exchange traded funds (ETFs) can be a useful means to spread portfolio risk more broadly.

 

Buying shares on credit is a strategy used by professionals in the stock market. They borrow money for a share purchase from a bank or a broker. After the share price has increased, they sell it again and take care of their debts and cash the difference as profit. But should the share price not increase and fall instead, the bank or broker expects them to pay more money. This so-called "margin call" can lead to high losses that far exceed the initial investment. Some small investors resort to loans from their friends or family instead of bank loans when buying shares. If the investment is unsuccessful, only broken friendships and broken families are left. This is why private investors should always stay away from equity trading on credit. The risk of large losses (for bank loans) and destroyed trust (for family loans) is far too high.

 

When buying shares, inexperienced investors tend to follow any recommendation by supposed stock exchange professionals. But an old exchange saying goes: “If the sparrows are already whistling it from the roofs, the stock is already too expensive.” In other words: If "the next big thing" is already in the newspaper, it's no longer an insider tip. Just think of the dotcom bubble, the bubble around the 3-D printer or the current block chain bubble. Although the technologies behind these are groundbreaking, private investors have lost a lot of money. Investors who recognized their potential early on and put their faith in them in the initial phases made the big money. This means that supposed insider tips are to be treated with extreme caution and should not serve as a reason not to conduct one’s own risk assessment for the securities.

 

Although share buyers have to demonstrate patience and nerve even when the share price falls, they do not have to accept losses without action. You should first define a lower pain threshold at which you are no longer willing to hold a stock. Stock buyers set so-called stop prices in their stock portfolio for this purpose. If the price falls below a previously fixed price, the securities are sold automatically - if the broker finds a buyer. This enables investors to protect themselves against drastic drops in prices. Stop prices should always be kept in mind. If the share price rises in value, the stop price should also be shifted upwards.

 

As an investor, you should never let your emotions guide you when buying shares. Fear is a bad counselor, but unfounded euphoria can also be dangerous. The average investor changes about a quarter of his stock portfolio in the span of one year, as the economics professors Andreas Hackethal and Steffen Meyer found in their research. The overzealous change their entire stock portfolio twice a year - and thus achieve the lowest return on share purchases. Trading costs for brokers alone reduce income by about 1%. In the case of particularly active investors, the trading costs of brokers even reduce returns by up to 3%. In order to avoid becoming a pawn of your emotions, you absolutely need a strategy. There are two basic investment strategies for buying stocks: value investing and diversification. Investors should develop a personal strategy that takes into account their risk preferences and their preferred investment preferences.  For example, are you looking for stocks with a high profit potential or stocks with high dividends?

 

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André Jasch

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