10 Painful Mistakes New Traders Make
Many new stock traders lose confidence and money when they first start trading on their own. By sidestepping common mistakes, new investors can avoid learning these lessons the hard way.
1. Believing An IPO ‘Can’t Miss’
Unfortunately, there was a whole class of first-time investors that got burned on the infamous Facebook Inc (NASDAQ: FB) IPO. Facebook’s IPO price had very little to do with the number of users the company had. Many buyers learned through this event popular companies aren’t always good investments.
2. Catching A Falling Knife
Momentum plays a powerful role in stock price movement. Just because a stock price is low doesn’t mean it can’t go lower. Sometimes it’s better to wait until a bottom has been clearly established before buying, even if that means you don’t buy at the exact lowest price.
3. Riding Losers
Stubbornness and pride are two traits that will do nothing but cost you money in the stock market. Nobody likes to admit they were wrong, but there is no sense in holding onto a bad investment and watching your money bleed away. Nobody’s perfect; just sell and move on.
4. Averaging Down
A very specific type of stubbornness related to bad investments is the idea of buying more stock at a lower price to lower the overall average price per share of the entire position. If you still believe that the stock is a good investment even after the share price has dropped, averaging down is a great trade to make. However, averaging down only compounds losses when a stock has fallen for good reason.
5. Ignoring Market Expectations
Ignoring expectations is a very common mistake that new investors make that leads to the belief that the stock market is "rigged." When it comes to stocks, it is not about how good a piece of news is; it is about how the news compares to the market's expectations. Sometimes good news can still not live up to the hype, and bad news is not quite as bad as was feared. The difference between news and the market’s expectations are what usually drives share price.
6. Data Mining
Many times, technical trading strategies are tested for usefulness by looking at past stock data (back-testing). While back-testing is one valid way to look for viable trading strategies, developing a strategy based strictly on patterns in a stock’s trading history can be dangerous. Sometimes patterns are just coincidence and nothing more.
7. Falling For Value Traps
According to Yahoo, the average P/E ratio of the office supplies industry is about 8.2, while the average P/E ratio of the information technology services industry is more than 18. Do these numbers mean that investors should be passing over the booming IT sector and be buying up shares of pencil makers instead? When was the last time your boss asked for a report to be handwritten in pen or pencil? Just because a stock is cheap doesn’t mean it's a good deal.
8. Chasing The Herd
TV analysts, market journalists and social media posters love to talk about trendy stocks. The problem with buying these stocks after they are popular is that there are no other buyers left at that point to drive the share price higher. In order to make money off of a trend, you need to buy a stock before everyone else does, not after.
9. Impatient Trading
It’s hard enough to pick good stocks to buy for the long-term. If you expect to see big gains in your account within a week, your expectations are too high. Making profitable long-term trades is not exciting and fast-paced. If you’re looking for thrills, save yourself a lot of time and effort and take your money to a casino instead.
Fear is one of the hardest human emotions to overcome, and when the fear has to do with losing hard-earned money, it is even harder to ignore. Rarely are the most rational decisions made in the heat of the moment. The best way to combat panic when trading is to decide on a thoughtful and clearly-defined exit strategy for each trade before you buy a single share of stock and simply stick to the plan when times get scary.
There are countless other mistakes that new traders make, but hopefully these 10 can be avoided. As with any other skill, don’t expect to be proficient at trading stocks right away. Practice makes perfect.
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