3 Ways You Can Lose Money in Stocks & How To Avoid Them.

Share this with a Pal

No one likes losing money. If you do like losing money, please make yourself known. I’d love to hear your case. Stock markets are certainly a place where you can lose a lot of money if you don’t understand them. People who don’t know a whole about the stock market will tell you you’re certain to lose money in stocks. This is for one of two reasons:

  1. They’ve lost out on an ‘investment’ due to improper analysis & are looking for something to blame or;
  2. Listened to an earful of whining from someone burned by reason no. 1.

Warren Buffett, perhaps the greatest investor the world has ever seen is on record multiple times for passing on his two overarching investing principles. “Rule No.1: Never lose money” and  “Rule No.2: Never forget rule No.1.” As simple as Rules 1 & 2 may sound, many new investors often find themselves making risky investments and witnessing the value of their portfolio drop suddenly, leaving a bad taste in their mouth for investing.

With all of the negative stigma typically surrounding the stock market, I thought I’d discuss how people actually lose money in the markets and how you can avoid it.

1. Losing Because You Lack Patience 

The stock market is not a vehicle for getting rich overnight and never will be. You can quickly lose most, if not all, of your invested capital by participating in day trading, or investing in highly volatile micro-cap securities if you’re not experienced. That’s not to mention the high brokerage costs, taxes and time-consuming nature of frequent trading.  

To protect yourself against losses in the stock market, tune out the ridiculous ‘once in a lifetime’ overnight success schemes and hone in on building a set and forget portfolio to hold for decades. Keep in mind that it takes planning and patience to build a successful portfolio. Like anything worth doing, successful investing will require some level of commitment depending on your strategy. You can learn more about different investing strategies here.

This one from Paul Samuelson sums it up quite nicely “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” 

2. Losing Due To Emotionally Driven Decisions

Investments driven by emotions, namely fear and greed, is a certain way to lose money in the stock market, period. You’d also be violating Buffett’s golden principals by making losses. You had one job! Success in investing comes from making decisions based on logic and reason, which in most cases isn’t what everyone else is doing. Most investors follow the herd’s mentality, perhaps the worst investment decision you could make. Following the herd occurs when investments are made based on the majority’s decision. Naturally, it’s difficult to go against the grain with respect to investing because if everyone else is buying and the stock is going through the roof you’re going to miss out right? Wrong. 

When you have the greatest urge to sell, is usually when you should be buying, and at times when you want to buy is usually when you should be selling. Fortunes are made when you don’t follow the crowd by investing in overvalued assets. 

During the Dotcom Bubble of the late nineties, investors poured money into a rising market pushed upwards by speculative investing into overvalued internet-based companies. Eventually, the excessive speculation came to a crashing halt in the early noughties when the NASDAQ-100 index bottomed out in late 2002 at  77% below its peak in 2000. Check out Investopedia for further reading on the Dotcom Bubble.

To ensure you don’t lose money in the markets, it’s best to make rational decisions for yourself and not get caught up in the outside speculation.  

3. Losing Because You Have Limited Understanding of Market Cycles  

Investors frequently lose money due to a limited understanding of the market’s cyclical nature. Stock prices rise and fall daily mainly due to the sentiment of the short term investor. The world’s best investors like, Warren Buffett, pay little attention to the day to day moods of the market. Instead, they focus on the long term (10+ years) prospects of their investments and avoid getting caught up in daily market price movements. Frequently checking the price of stocks in your investment portfolio is like requesting a daily valuation of your home. Pointless. Great investors prioritise staying informed with their current investments by ensuring their fundamentals are heading in the right direction. 

Price fluctuations have only one significant meaning for the true investor. They provide an opportunity to buy wisely when prices fall sharply, and to sell when they rise. 

Let’s take December 2018 as an example, The S&P 500 lost 11% percent of its value for the month. It was the S&P’s worst percentage drop since The Great Recession in 2007/8. Fast forward to February 2019 and The S&P was back to it’s December highs. For the astute investor, Decembers 2018’s mini-crash came as an early holiday season gift from the market. Investors were presented with the opportunity to buy wonderful businesses at cheaper prices.

If you sold your investments during December 2018 you would have most likely lost money. On the flip side, by remained disciplined & understood the value of your investments you would have likely been rewarded for your patience as stock prices returned back to their original positions 3 months later. Or even better, bought more.

Summary

Stocks are commonly referred to as a gamble of sorts by people don’t understand them. In reality, losses in the stock market come from misconceptions. Next time you’re thinking of buying or selling, make sure you’re mitigating your risk by avoiding the common causes of loss listed above. When you are ready to start investing, check out our Guide On How to Make Your First Stock Investment in Australia.

P.S. I’d love to meet you on Twitter: here.

Want to see more articles like this? You can sign up for our newsletter to get free content first by e-mail! You know you want to.

Disclaimer: This website (The Money Pal”) is published and provided for informational and entertainment purposes only.  The information in the Blog constitutes the Content Creator’s own opinions. The information should not be regarded as financial advice. 

Related posts

Leave a Comment