5 surefire ways to lose money on stock investments

2024 Author: Malcolm Clapton | [email protected]. Last modified: 2023-12-17 03:44

Speculate, borrow and choose industries you don't understand. You’ll be very lucky if you make anything like that.

1. Invest in obscure assets

Any investment is a risky undertaking by definition, because we do not know what will happen to the economy and business in the future. This means we can lose money. But this risk can really be reduced if you understand a little.

First, you need to understand how the asset in which you are going to invest generally works. If these are stocks, then figure out why they are needed, why they rise or fall, how do growth stocks differ from dividend stocks. It's the same with bonds: you need to imagine why they exist and how to make money on them.

It is important to understand the market and business even deeper. You need to spend time and understand the company: what it does, how it earns now and how it can earn in the future, what are the financial forecasts and what analysts say about the change in the price of its shares. There are many more factors that affect firms, from politics and taxes to news and specific industries.

For example, stocks of major automakers like Toyota or Ford fell due to a shortage Surviving the silicon storm: Why the automotive industry is the hardest hit and how automakers-and other chip buyers-can prepare for future semiconductor shortages / KPMG of semiconductors - special materials. which conduct current.

Modern cars have a lot of electronics, and without, for example, germanium or zinc, they cannot be assembled. This means that the fewer semiconductors on the market, the fewer cars and the lower the profit of their manufacturers.

But if the investor understood the situation, he could earn twice:

• Buy shares of automakers that have temporarily fallen in price: the companies will one day restore production, and the demand for new cars will be high.
• To buy shares of semiconductor manufacturers that have not yet risen in price: these firms are already making a lot of money, because materials are needed for machines, computers, and medical equipment.

What to do in order not to lose money

• Study how financial assets work: stocks, bonds, or ETFs. Invest only when you understand the mechanisms.
• Understand how the companies you are interested in, the sectors of the economy and the countries in which you want to invest are arranged.

2. Invest borrowed money

Sometimes it seems that you are already an investment Nostradamus, or at least Warren Buffett - you know exactly how the stock market will behave. I would like not only to invest my money, but also to borrow. Like, all the same, the profit will be huge, you will beat off the interest and return everything.

This approach even has its own term and a separate service - margin trading. This is when an investor borrows assets from their broker and uses them to capitalize on the difference in the price of shares. For the service you need to pay a commission plus one return the assets to the broker. But investing is a risk, especially on such conditions.

Losing your money is sad. Spending someone else's is disastrous.

For example, electric car maker Tesla has many 1. Tesla Stock Downside: $ 0? / Trefis

2. A. Mehta, G. Bhavani. Financial Statements Analysis on Tesla / Academy of Accounting and Financial Studies Journal

3. Goldman Sachs: It looks like demand for Teslas has peaked / Business Insider predicted bankruptcy or a gradual fall in the share price. Since its foundation in 2003, the company has been unprofitable: it had profitable quarters, but at the end of the year it was losing $ 600-800 million.

Some investors thought that the company's shares would definitely fall, so they used margin trading short. Exchanges do not permit the sale of securities that investors do not own. So they borrowed S3 Analytics: TSLA Shorts Down - $ 4 Billion This Week / Shortsight from their stock brokers for $ 22 billion, sold them and waited for the quotes to fall. If Tesla's share price fell, investors would buy up the fallen ones, return them to brokers and receive income. But in 2020, the company went into profit for the first time, and its shares rose 893%.

Suppose that two investors bet on the fall in the price of the company's shares: the first with their own money, the second with borrowed ones. At the end of 2020, both made a mistake, but lost in different ways. Let's calculate their losses, but for the sake of simplicity, we will not take into account the commissions: with them, the losses will turn out to be even higher.

The first investor has $ 86, which is exactly what one Tesla share cost. For the amount that he had, he borrowed a share from a broker and waited for the price to fall - this did not happen. By the end of the year, the investor bought the stock back to repay the debt, but then its price reached 768. To the deferred $ 86, another 682 had to be added. This is precisely why margin trading is dangerous: the loss can be serious, even if the initial rate is small.

The second investor believed in himself too much, so he asked the broker for ten shares for $ 860 - on credit, without providing his own money. By the end of the year, the investor will owe $ 7,680 - and may have to sell the apartment just to pay off the debts.

What to do in order not to lose money

• Never raise borrowed money if you can't get it back in the worst case scenario.
• Decide which part of the portfolio you are willing to risk Portfolio Risk and Return: Part 1 / CFA Institute. Professional investors rarely invest more than 3-5% in one asset.

3. Speculate if you are just starting to invest

Speculations are investments in assets for the purpose of their quick resale when prices rise or fall. This is done by traders who have specialized knowledge, access to a heap of data and indicators.

Traders speculate on both the stock and derivatives markets. The latter is their territory, because contracts with a certain period are concluded on it, mainly futures and options. Let's say a futures on a stock, that is, a contract for their purchase and sale in the future, but at a price agreed in advance.

For example, there are futures on the price of Aeroflot shares. The trader could easily buy them in February 2020 and wait for profits: the shares of the corporation should rise in price by the summer, because the season of vacations and flights will begin. But in reality, Aeroflot lost its flight connection due to the pandemic, the company did not earn anything. Therefore, both its shares and the price of the futures fell by 40-50%.

Professionals usually trade in the derivatives market, and even they often make mistakes. Although traders sit at their monitors all day and analyze trading signals, specialists lose to the market. Data vary greatly 1. F. Chague, R. De-Losso, B. Giovannetti. Day Trading for a Living? / SSRN

2. D. J. Jordan, J. D. Diltz. The Profitability of Day Traders / Financial Analysts Journal, but it looks like 60 to 99.6% are losing money. Those who do make money lag behind ordinary investors: traders have B. M. Barber, T. Odean. Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors / The Journal of Finance 11.4% per annum versus 17.9% for those who once invested in a stock index and forgot about it for a year.

Despite this, trading has not disappeared anywhere. There are two main reasons. This is possibly R. Guglielmo, L. Ioime, L. Janiri. Is Pathological Trading an Overlooked Form of Addiction? / Addiction & Health, not yet fully described form of addiction, like gambling addiction. The best traders make Trading performance of the best traders (2021) / Kagels Trading so much money for their employers that they cover losses from unlucky colleagues.

What to do in order not to lose money

• Study attractive assets carefully, taking your time to make money here and now.
• Invest for a medium or long term: from a year or three to infinity. For example, the S&P 500 stock index for 100 years brought the Compound Annual Growth Rate (Annualized Return) / Moneychimp to its investors 9.53% return. And this is adjusted for secular inflation and without any other trade.

4. Trade assets at the slightest market fluctuations

Some investors try constantly B. M. Barber, T. Odean. Online Investors: Do the Slow Die First? / SSRN monitor the stock market: not for the sake of daily trading, but to catch the moment. If the assets in their portfolio have grown slightly, then you need to immediately fix the profit, if they fell, reduce the loss.

In fact, this is a nervous occupation that takes up energy, time and eats up profitability - such investors receive approximately K. Akepanidtaworn, R. D. Mascio, A. Imas, L. Schmidt. Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors / SSRN is 3% less annually than calm colleagues.

Let's say an investor has shares in Tinkoff Bank. In the spring of 2020, the founder of the company, Oleg Tinkov, announced an illness - and the share price collapsed by 40% in a few days. Four months later, it returned to its previous level, and a year later the share was worth twice as much.

A fussy investor would rush to sell stocks and lose money. A calmer one could analyze the situation, buy more during the fall and earn more.

Half of the losses in trading in the stock market are K. Akepanidtaworn, R. D. Mascio, A. Imas, L. Schmidt. Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors / SSRN wrong decisions about when to sell assets. And this is for professionals. Novice investors manage on average B. M. Barber, T. Odean. The Behavior of Individual Investors / SSRN is even worse.

What to do in order not to lose money

• Remember that attractive assets do not get worse due to price fluctuations. Market volatility will pass, and the company will continue to grow.
• Build a diversified portfolio: invest in stocks, bonds, ETFs, real estate and commodities.
• Select companies that are of interest to you. Pay attention to size, financial indicators (profit, debt, growth rate, free money), development prospects, environmental friendliness, sector of the economy, or the size of dividends.
• Finding the right investment timing that differs from firm to firm. For example, it is necessary to invest in fast-growing companies on the principle of “the sooner the better”, and in an overvalued corporation - during the next crisis, when it becomes cheaper.

5. Act on emotions

Just succumb to the general mood and love the company that everyone is talking about. Or read about the collapse of the oil economy in all the media and run to sell shares of oil companies. These emotions - the hope of earning and the fear of losing - influence 1. D. Duxbury, T. Gärling, A. Gamble, V. Klass. How emotions influence behavior in financial markets: a conceptual analysis and emotion-based account of buy-sell preferences / The European Journal of Finance

2. J. Griffith, M. Najand, J. Shen. Emotions in the Stock Market / Journal of Behavioral Science on the actions of investors. Emotional behavior makes market volatility higher and investments more risky.

There are many examples of such solutions. Biotech company Theranos has allegedly created a breakthrough blood test technology that would change how laboratories work around the world.

Investors liked it so much that large funds valued a loss-making firm with no real sales at $ 10 billion. However, later it turned out that there were practically no developments.

A scandal began, the owners of Theranos liquidated the company and ended up in court for fraud, and the money invested was gone.

A less dramatic example is cryptocurrencies. Looks like T. Aste. Cryptocurrency market structure: connecting emotions and economics / Digital Finance, they - and even bitcoin - are strongly influenced by investor sentiment. In a month and a half, the largest cryptocurrency first collapsed by 40% after critical tweets from Elon Musk, the founder of Tesla. And then it grew again by 10% after his own posts on the social network.

What to do in order not to lose money

• Overdoing yourself, especially in times of crises and ups in the stock market, is the most emotional time when it is easy to make mistakes when buying or selling assets.
• Wait until volatility returns to normal. Investor will not receive Does Market Timing Work? / Charles Schwab of super-high profits, but you don't have to take risks either.