Making money in the stock market requires a lot of discipline and patience because share prices can be volatile and unpredictable.
Many first-time investors enter the market with huge expectations that they can get rich quick by trading stocks, but many end up losing their hard-earned money.
The truth is that there is always a risk of losing when you invest in the stock market. It is a risk that you cannot totally avoid. Every investor in the stock market is going to lose money at some point, but if you don’t know how to trade properly, you will lose more frequently until your investment capital is exhausted.
Your goal as an investor is to protect your investment by understanding your risks and knowing how to manage your money carefully to avoid large trading losses.
Trading in the stock market can be profitable but not everyone makes good money from stock investing. More than the thrill and suspense of playing in the stock market, you need to know why many first-time investors fail in their trading journey and how to overcome it in your favor.
Here are the five reasons why new investors lose money from trading in stock market:
1. Failure to develop a good trading plan
Remember the saying that “failing to plan is planning to fail?” Before you enter the stock market, you need to make sure that you have sound trading plans that identify the type of stocks that you want to trade, the returns that you expect to make and timetable to achieve it.
Your trading plan must be able to differentiate your short-term and long-term strategies. There are stocks that you want to buy for trading purposes and there are those that you want to buy and hold for the long-term.
Very often, many first-time investors make the mistake of chasing stocks for short-term profits that end up as long-term investment while others sell their stocks too early for small gains in exchange for long-term capital appreciation.
Every trading plan varies from one investor to another because of differences in risk profiles. When you develop your trading plan, you also need to include your risk management strategies. How much losses are you willing to tolerate if you make the wrong bet? How do you minimize your risks of picking the wrong stocks or buying at the wrong price?
Having a trading plan is not only about having a strategy. It also needs to be workable so that you can comfortably stick to it no matter what the situation is.
2. Failure to manage emotions that affect trading decisions
The stock market is driven by two kinds of emotions: greed and fear.
There is a big temptation for first-time investors to get caught up in greed when stock prices are rising sharply. When you see how much a particular stock has gone up and people are chasing it like crazy, will you be tempted to join and hope to make a quick buck out of it?
Similarly, just as the market can be dominated by greed, the same can also happen with fear. When the stock market crashes and every stock you see seems to be losing no end, will you sell all your stocks to get out of the market?
Being too greedy or fearful can be costly because it forces you to make decisions that you may regret later on. Sticking to your trading plan while controlling your emotions regardless of market sentiment, whether good or bad, is the way to succeed in investing.
3. Failure to cut losses on bad trades
It is a common mistake to fall in love with a stock but when it is already losing, you must do something about it or you risk losing more if you allow it to linger on.
If you have a reason to believe the stock will fall deeper, you can cut your losses while you still have good chances to recover your capital. For example, if a stock has fallen by 10 percent, taking a loss at this level will give you the ability to recover your losses faster because you only need to earn roughly the same 10 percent by investing the proceeds in other stocks.
The problem is if you are emotionally attached to the stock and you prefer to wait until it recovers to break even, you will risk losing more, making it harder for you to recover. For example, if your stock has already lost by 50 percent, it will need the stock to go up by 100 percent in order for you to break even.
4. Failure to take profits on good trades
It feels good when you see your stock doing well and showing gains in your portfolio every day but the gains that you see on paper are not yet your actual profits until you sell your stock. The gains that you see may eventually disappear when the stock reverses and go the other way.
If you have identified how much you want to make and your stock has already achieved that objective, you may consider locking in your profits by selling your stocks. If the stock is still on uptrend, you can consider selling slowly as the share price increases until you sell all your stocks.
Many make the mistake of waiting to sell their stocks at the highest possible price to maximize their profits. If you do this, you may never be able to sell it because you will never catch it. Sell while it feels good.
5. Failure to improve trading skills by studying
Most first-time investors do not have background in trading and financial markets. You may not have the actual experience in buying and selling stocks in the market, but you need to at least have a solid understanding about investing in the financial markets.
There are two types of analyses that you need to learn to improve your investment skills: fundamental and technical. Fundamental analysis pertains to understanding how geopolitical and economic factors affect the stock market and financials of the company. How do you value a stock based on earnings growth? When do you say a stock is cheap or expensive?
Technical analysis, on the other hand, pertains to the understanding of market psychology and price trends by looking at historical charts. This skill is important when you need to identify at what particular price you should buy or sell a stock based on historical support and resistance.
Henry Ong, RFP, is president of Business Sense Financial Advisors. Email Henry for business advice firstname.lastname@example.org or follow him on Twitter @henryong888