Investment purchase is often a natural start in adventure of many individual investors of their development after switching from investment to funds or bonds. Many of investors duplicate several myths and bad practices that are popular in the literature and the internet. The only one effect of such actions is a decrease in investments and even a painful financial loss.
1. Buying Stocks in downward-trend
It seems that it is very easy to avoid this mistake. It is enough to not buy stocks that have been trading for a long time in a downtrend. Assuming that we can identify according to the Dow theory in which the trend is given, never again such a mistake should not happen. Unfortunately, the sharp falls in stock prices are often used by small investors as a bargain for purchases, according to the motto If there is a sale it is worth buying. Most often, however, a strong discount has some underlying ground, which investors do not necessarily need to know, which is mainly due to asymmetric information on the market.
I often see questions about falling values Is it worth buying? or Is it cheap enough? Well, if it is cheap enough, nobody knows, but most often it turns out that in the downward-trend may be even cheaper. As with the upward trend, so and downward they can take courses in areas that analysts did not even consider a few months earlier.
JSW after the first strong candle in 2011 may have been an interesting proposition and investment opportunity. As it turned out later, it was only the beginning of a downward-trend that lasted several years. There were also 75 or 60 PLN levels, because the bottom of the course was found below … 10 PLN. No one in 2011 expected that the downward-trend will reduce the valuation of this asset with WIG20 by over 90%.
Therefore, it is best not to buy shares in downward-trends, do not look for a hole or opportunity. It is better to focus on those in the beginning of upward trends, or to look for corrections of earlier increases, and to catch falling knives leave … catchers of these.
In the recognition of the downward-trend, the most secure way is to stick to the Dow theory. If the course produces significant lower peaks and troughs – you can talk about this trend. A helpful tool is also the moving average, appropriately selected for the graph type. For daily chart, they can be average 100 or 200 days. For the weekly chart, the optimum for a long-term trend will be an average of 30 or even 40 weeks. For monthly charts, it’s best to check the average of 15 months. The slope of the downward-trend is a testimony to the earlier falls and a downtrend.
2. Buying weak stocks in weak sectors/ weak market
Another mistake, most often due to ignorance, or too briefly checking the situation of the purchased item. Most of the companies on the Warsaw Stock Exchange belong to some index (except for WIG of course). Sometimes it even belongs to several indexes (e.g. WIG20 and WIG-Banks for PKOBP). When analysing the technical situation on the chart of a company, it is also worth checking how the indexes to which this company belongs. Often, a promising technical system can be defeated by being part of an index that is in a permanent bear market.
Why is this happening? Capital flows from one type of company to another. The most common factor is the impact on the whole industry (e.g. the increase in interest rates should have an impact on banks), and by investors (also institutional) who dominate the fashion for specific values. Holding indexes that are not in the downward-trend (or best of breed), we have a better chance of avoiding stock marketers and even getting caught up in a bull market.
This year the growth of sWIG80 ended practically in mid-April, while WIG20 continued its good run. Sticking to a stronger index gave a statistically better chance of a better return.
By evaluating the trend of major indices, it is easy to identify the moment of transition to a bear market and the good time to withdraw some or all of the funds from the market. Being able to stay out of the market (and possibly replenishing short positions) is one of the main advantages of individual market participants over the funds that must remain on the market, even when the conditions for investing are not favourable.
In spite of the global bull market in 2009, including the US stock market – SPX, the Greek stock market index – ATH, from mid-2014 to the end of 2016, it remained in a bear market. It was a good example of a market where it was better to wait short or to hold short positions.
3. Averaging down
A common mistake among beginners and not just investors is to average long positions (e.g. on shares), which, contrary to assumptions instead of rising – falls. Less often, one can encounter the opposite situation, in the averaging of the growing short position, which is mainly due to the less popular game of decreases (and fewer opportunities for such investment) as well as the rooting of the generally correct dogma that Markets grow in the long-run.
Unfortunately for bullies, investors often have to wait very long for growth. A good example is the index of the Japanese stock exchange, which lost in the beginning of the 90s of XX century made up only in 2017. You can not wait to see them, for example, companies that are withdrawn from the stock market due to bankruptcy.
Averaging down is often combined with the martingale strategy, which in the case of strong downward-trends leads to mournful results (especially on leverage markets such as futures or Forex). Because financial instruments tend to move in the trend, the further increase of the losing position, which is expected to reduce the percentage loss, only increases the amount of money when the instrument continues to decline.
Defenders of averaging down course will answer that in case of rebound is the possibility of reducing losses or even earning on such position. Unfortunately, the upward trend in downward-trend does not tend to meet downward averages, and as a rule they come too late or are too small to change a lot for such positions.
The last argument against averaging down positions is logic. Logically acting man does not duplicate the mistake made by counting on another result of his actions. Similarly, on the market, increasing the losing position in the downward-trend is an action contrary to logic. In line with the trend of the stock, you should increase the gaining position (pyramid) in the upward trend. However, this activity is much smaller among small investors …
4. No patience / Sluggish decision
These opposites act in a manner contrary to appearances as a mistake in positioning. The first case is usually a quick pull of profits as they appear. This is probably due to the tendency to get an immediate and guaranteed reward of even a small profit. Unfortunately, it is often the case that a sold position in a hurry can grow much stronger, and the investor is without action and can passively look at further growth.
It was not the best idea to get a 21% profit in two months in the summer of 2013 on CDR. By showing patience and properly leading the position, it was possible to obtain over a four-year profit of over 1400%.
The opposite situation, or clinging to action, can also lead to considerable problems. While in the case of an up trend, such performance is a great benefit, when the trend reverses (especially when it is a burst of speculative bubble), the previously profitable gains can quickly turn into severe losses. Investors who, like a Rottweiler, when they buy shares, do not let them go – in the event of a serious breakdown in the market (a bear market) they lose previously earned profits and, at best, end up with minimal profit or have to swallow painful losses.
Buying Getin at the end of 2012 did not guarantee a profit (about 50%) if it was not implemented in good time. The lack of a decision to sell at the beginning of 2014 could lead not only to zeroing out the previously earned profit, but also to enter into a deep loss two years later.
Summing up, when conducting every position on the market, you have to have a plan and flexibly react to possible variants, both with considerable success and failure. What’s more, the action can not be too hasty or too late. Possession of specific defence points (Realized Loss) in the event of failure as well as the assumption of a specific way of running a growing position (from a fixed level of profit – including profit or running a position with a movable stop) should be the basis of a set plan before you buy a specific value. This will help you avoid making the above mistakes, for example under the influence of emotions.
5. Buying stocks too late
Given the above mentioned mistakes, it would seem that it would be enough to buy only companies in the upward trend, preferably at the time of correction and accordingly lead to rising positions to generate steady profits from the market. Well … it’s only half-truth. While keeping up with growing companies gives you the edge over the market, it is important to remember that not every growth trend is a great opportunity and not every company will be able to grow for years. Just as the downward and downward-trends tend to end and change their direction. Therefore, joining a long-lasting trend (in particular over a year) is subject to a certain risk. The older and longer the trend, the higher the risk, because, according to another stock theory, What has grown up strongly, has to fall heavily. In an extreme case, looking for a strong and old trend can be hooked up to the top of the speculative bubble at a given price.
Therefore, when joining the upward trends, it is necessary to consider the potential of an increase (upside), which is influenced by historical resistance in the chart, the duration of the trend and the scale of the traffic. Another important factor is the condition of the trend. While there are sudden transitions from upward to downward-trend and vice versa, they are rare. Most often, trends are terminated by consolidations or movements with a larger amplitude, which can create specific price formations (for the endings of upward trends, e.g. RGR formation, double peak or wedge increase). Such behaviour in the long-term trend should be a warning for those who want to occupy a new position in it.
The late entry mistake is often duplicated by investment fund clients. They often check the rate of return from the previous (or several previous) periods and choose the fund that showed the best. While over a longer period the rates of return may actually indicate greater or lesser managerial skills or the advantage of the strategy used, the annual or shorter return rates are often derived from happiness or specific market behaviour (e.g. strong growth in one sector). Stock exchanges and trends change virtually every year, and what has grown up strongly in one year is not necessarily a guarantee of strong growth in the next year.
A table of several assets over the years 2005-2015 with a distinction of gold return rates. Only copper and SP500 have been able to maintain the leader’s position for at least 2 years in a row. Similarly, at the bottom of the list only once happened to the last place took the same asset (Bony USA). The gold highlighted in the table also did not give a guarantee of a fixed rate of return, ranging from 30% growth to 27% decreases per annum. So every year brings so many changes and rotations in return rates of assets. Source: http://www.investors.pl
In conclusion, getting rid of some bad habits and mistakes often resulting from misleading beliefs about the market will certainly reduce your risk as well as improve your own investment performance. Of course, the above Top 5 does not exhaust the subject of all the mistakes that can be made when buying stocks, but it is a good starting point for improving your own investment strategy.