I know the title for this article might sound crazy because most financial writers will write about ways to make money out of the market. Here I am, telling you how to lose money in the stock market. The purpose of this article is not to teach you methods to make money but rather to teach you how to avoid landmines in investing.
Preserve your Capital
While I was still in the financial industry back in the 1980s in Auckland, New Zealand, I remembered during one of our training sessions where we enlisted a professional trainer from outside our firm. What he (the trainer) did back then was basically teaching us to sell all day. We are given a mock account and we trade using this account, then all of a sudden he (the trainer) instruct us to liquidate all our positions in our portfolio. This happens several times during our training session. I asked him why he instruct us to liquidate all of positions when some stocks are making a loss while others are still having a good run? His answer is ‘It will help to protect your account’.
It took me many years until I traded myself to realize what he meant. Many of us tend to hang on to our losers forever because we are too attached to the companies that we are invested in. In times of crisis and market crash, many a time our portfolio gets wipe out because of our unwillingness to sell. So now I know reason why he wanted us to sell at any time and moment without thinking of what we have in our portfolio. His mission is to train our mindset to handle situations during crisis and that is to clean out our portfolio.In other words he wanted us to preserve our capital to fight in the next round.
There are literally thousands of books out there that teach you how to make money in the market. Many teach you the same old rules or clichés on trading that I reckon that you are sick and tired of them. Clichés like Cut your losses and let your profits run, avoid margin accounts and don’t average down are some of the rules that you probably heard more than one thousand times during your trading career. Studies shown that the more complex your trading system is the more money you will lose. Many of us forgot that to be successful in the market, all we need is a basic and simple trading system coupled with good discipline.
It is true that no matter how many top notch newsletters you subscribed, most advanced trading system you purchased, the best technical analysis software program or how many stock market guru you followed yet you will not be successful if you lacked the basic ingredient and that is self-discipline. Without discipline you tend to based your trading decisions on various sources of information like newsletters, rumors from friends, stock tips from your neighbors and you end up being confused due to information overload and conflicting views. One newsletter will tell you to buy while the next will tell you to sell and similarly with the different conflicting recommendations from various analysts.
Unable to discipline ourselves made us lacked confidence and hence led us to follow what the crowd does as they too are following the ‘herd instinct’. Unable to act on ourselves, we tend to look for a leader and hence such behavior or emotions led us to follow others where we sell into bottoms or panics and buy into market tops or euphoria. This has led us to conclude that there is a close relationship between the intensity of human emotions and market turning points. Thus emotions can be your friend or enemy depending on how you approach it. During financial panics and crashes we must know how to muster our courage to buy when the whole world is selling or sell when the panic crowd is buying into a frenzy or euphoria. By mastering this technique we are able avoid the madness of the crowds as psychologist Friedrich Nietzche puts it in the following.
Madness is rare in individuals, but in groups,
Parties, nations and ages, it is the rule ….
By Friedrich Nietzche
How to Wreak Havoc to your Account
So to improve our trading career instead of learning from what is already known, why not we learn from the mistakes committed by others. The following are some of the surefire ways not only to lose your money but also your pants, if you practice them.
Read various publications, watch Business News and follow popular opinions
This will guaranteed to confused you with various calls by the experts and hence lose money at the same time. When you based your trading decisions on the basis of popular opinions then it will lead you to the crowds. Research shows that you are better off trading against the crowd than with it or what we termed as ‘Contrarian Investing’.
Cut your Profits and let your Losses run
Losers normally employ this strategy. A lot of investors are very anxious when their portfolio is in a profit. For too many times in their investing career they have ‘been burnt’ for holding on to winners for too long. Eventually they gave back their profits when the market turned. To avoid making the same mistakes again, they now followed a new strategy which is ‘A bird in the hand is better than two in the bush’. Hence they quickly cash in their profits so that the market cannot take it back again. Another wrong strategy they employed is holding on to losses for too long. They simply cannot admit to losses and tends to hang on to it and hope that the market will turn around one day. But such turnaround normally will not happen and their positions will tend to erode further. This is because battered down stocks will not likely be candidates for stocks to watch in the next run-up. This is a classic case of one step forward and two steps back.
Making a fortune from a Small Outlay
It is not surprising to see many traders start off trading with a small sum in the hope to make a living out of it. The simple fact is the smaller your capital the lower your success rate. This is because in trading we cannot get it right in every trade and sometimes we will experience a few losses in a row. Hence with a few losses here and there before you can even make it big, your capital is already depleted. In the game of stock market investing even a professional finds it difficult to make 5% per annum. If you start off with say $20,000 and expect it to make enough money to pay for your monthly expenses of $2000 then your odds will be extremely slim. This strategy will guarantee you to lose your shirt.
Pyramid up your Gains
This strategy will guarantee you in losing your money. This is the opposite of averaging your losses. A lot of traders thought that when the market is moving up, profits can be multiplied by averaging up with more contracts. The problem with this strategy is that you are building the pyramid upside down or an inverted pyramid. You started with 5 lots of ABC Company and when the market moves up, you kept adding more contracts. As more lots are built up at the top, the structure will be weakened and any market turnaround it will send it crashing down like a house of cards. This can be shown by the following diagram.
The above inverted pyramid has 5 levels and as you can see as time goes by more shares are bought which in turn contributes to the instability of the structure. The right strategy will be to build a larger base with a smaller top like a normal pyramid. That means you buy fewer lots as the market progresses.
Picking Tops and Bottoms
This is in the opinion that the lower you buy and the higher you sell the larger will be your profit. Well, only inexperience investors will follow this strategy because we never know where is the top and bottom of the market. Our objective is to buy at near bottom or sell at near top. Even the professionals cannot determine the top and bottom. Trying to determine the top and bottom is dangerous because volatility tends to be very high at near market tops and bottoms. Hence if you are wrong, then you are in for big surprises.
Trading on Advice from Newsletter or Money Manager
This is another surefire way to lose money. There is always a temptation to go with the advice from a Money Manager or Newsletter when their performance is outstanding. Or when their recommendations resulted in a string of winners and attracted a lot of attention. The point is that if their recommendations are so good and profitable then why should they share their secrets of minting money with you? They might as well trade themselves and why bothered with all the complaints and pressure to perform? The problem with this strategy is that during periods when it attracted the most attention, it normally signals a market top. We do not need to elaborate on what follows.
Quit your Job and start full time Trading
Many investment Gurus tends to tell people that it is better to trade full time rather than part time. They reckoned that by trading full time you will be more in tune with the market because it is better be ‘then and now’. But the actual fact is that there are more traders lose money this way that any other. It takes time to learn the ropes of trading. By having the best software, computer and broker will not make you a successful trader. You must have a trading plan that is simple to follow and does not need complex calculations or procedures to adhere to. All you need is some self-discipline and simple rules to follow such as a good market setup, money management and trade management.
Above are some traits that will guarantee you to lose money in the market. By following some of the strategies above, we guarantee you will be sent to the Cleaners soon. If you are practicing some of them then we reckon you should unlearn them as soon as possible. Try learning some self-discipline and when you have mastered your emotions then you will master the market. This we can guarantee you. In looking deeper onto the above, we conclude that there is a direct relationship between our ability to read the masses emotions and our profits. If we can identify which direction the emotions are heading (without getting influence by it) then our right strategy is to bet the opposite because the market will soon turned the other direction.