Common Stock Trading Mistakes
Submitted by Sara Worley & Brendan Donahue
Investment Advisors, Manulife Wealth Inc.
Everyone makes investing mistakes at one time or another. Learning how to recognize and avoid as many as possible can help an investor prosper. Here are a few.
Familiarity
Investors usually succeed if they buy what they know. The problem is, investors sometimes equate this advice with buying stocks of companies that make products they are familiar with. In other words, liking Lululemon Athletica’s yoga pants isn’t a good enough reason to buy their stock.
To make a sound decision, one must look very closely at a stock’s fundamentals, competition and sector trends. If the answer is unclear, people should only invest an amount that they are comfortable with losing.
Short-term bias
Investment research is based on a 12-month outlook, while stocks are priced minute-to-minute. This can make the relationship between the two appear disjointed. For example, as of September 25, 2019 Credit Suisse assigned a 12-month price target of $209 on shares of Apple Inc (AAPL) however, the shares traded as high as $232.07 and as low as $142.19 over the past 52 weeks.
It can be easy to get discouraged by price fluctuations, but investors must remain patient and focused on the long-term. Have things really changed for the company fundamentally or are price movements just market action? Moreover, if a stock’s price swings too much for a person’s comfort, it’s probably too risky for them.
Dividends
A strong dividend can be a sign of a healthy, prosperous company, or that a stock is temporarily undervalued, presenting a buying opportunity.
It can also be a sign of trouble. A dividend of more than 7 per cent in an average-priced stock market tends to be a warning sign. And from an overall performance standpoint, price declines on a stock can chew through dividend income in a hurry.
To avoid dividend bias, pick fairly priced, high quality stocks with average dividend yields. This should help balance out returns by adding a capital gains component.
Chasing past returns
It happens all the time: people hear about a stock on television or the golf course, notice that it’s going up and buy in hopes that the trend will continue. Often, all a person knows is that the stock price is increasing, or that someone they know made a lot of money owning it.
The problem is that some people who buy stocks like this might not truly understand what they are buying. Historical winners might seem foolproof but consider the dotcom bubble in 2000 and housing crisis in 2008. That’s what happens when people crowd into specific investments or asset classes with little regard for fundamental analysis.
The bottom line is, it’s ok to dabble in hot stock ideas, but self-control and diversification are imperative to avoid getting caught in any one stock or sector.
Doubling Down
Sometimes, investors try to break even on a losing stock by doubling-up on the shares when they’re under selling pressure. This is done so that even a 50 per cent rebound will bring the total investment back to par.
This is almost always a bad idea, as most investors lack the ability to time the markets correctly. Further, there will almost always be something better to buy. The smart investor will cut their losses and move on.
Never selling
Many people wonder why their advisor will recommend they sell some or all of a particularly profitable stock. If a stock is doing well why would they sell it?
The truth is, never selling even a portion of a winning stock can be just as costly a mistake as doubling-down or holding losing stocks too long. A gain is not truly earned until it’s realized. Savvy investors will sell profits as they go and reinvest in attractive new opportunities.
Final thoughts
Sometimes all it takes to succeed is to win by not losing. Applying less emotion and more analysis are sure-fire ways to ensure smarter investment decisions.