Sunday, August 17, 2014

Why retail investor loose in Stock Market

Where the stock market will go next is the question which everyone wants to answer because in it lies the road to immense wealth. Unfortunately no one gets it right not even Warren Buffet. Every day morning the analyst in all the business channels give targets one after another as if they are putting butter on their bread. Most of these analysts are bearish or bullish based on how their investment is lied up. This has nothing to do with the reality. It's a perception which is driven by their vested interests. An investor who is fully invested will be bullish whereas an investor with cash will be bearish. This is same thing that anyone of us would do. The difference is that we do not speak on news channel. If I am holding stocks, I will expect for the stock market to go up and if I have cash I will expect it to go the other way round.
Many times we hear about valuations not supporting fundamentals. I wonder if valuations ever support fundamentals. And actually no one knows what is the mathematically precise definition of fundamentals. And if stock will start supporting fundamentals than only time the share price will move will be during the quarter results. Otherwise everyone is hoping that some one else shows more greed than they have got. And usually its the retail investor who has the maximum greed and loose the most. When you ask a retail investor about the huge pile of loss that they are sitting on they will happily tell you that they only believe in going long. They are investor and are for long term in the market. It's not that the institutional investor do not loose, but the incidents of losses is more prominent with retail investors.
The two biggest mistake a retail investor does is:
  • To enter the market very late.
  • To forget to sell.
  • To act on tips given by their hair dresser.
Retail investors are usually one who enter the market very late, usually the last of the lot before the market starts downward. People get frightened when the market is making lows and become highly optimistic when its making highs. The higher the market the higher people expect it to go. And when it starts coming downwards, it comes so fast that the retail investor is caught off guard.
Another mistake retail investor does is to forget to sell.So many people catch cold feet when the market starts going up. They just forget to sell the stock in spite of getting good return. The greed becomes so heavy that they start building castle in the air. Every second they will click their portfolio and feel happy over the virtual money. And than suddenly the market starts going down. They still hold on in thinking that the dip is momentarily and the stock will again start going up. And one fine day it's so low that they stop looking at the portfolio. The feet are more colder. Than they start quoting Warren Buffet that they believe in only going long. They will vociferously argue about the virtue of long term investment. Most of them do not look back to their portfolio for years or for life.
Why retail investors fall in this trap time and again and how to avoid them? The main reason for this is that retails investors start looking for infinite returns. They blindly assume that the market is there for them. Also they start relating the returns to the dreams and needs of their life. The moment you move the expectation from achieving a realistic percentage term return from your investment to owning a Ferrari from the stock value, you are never going to sell your stock till you can buy Ferrari out of it. The stock value may take you to buying a Toyota Corolla and than brings back to the place where you can hardly buy a second hand car.
How to avoid these risks and hazard associated with it? Follow some basic steps and principals and you will be better off.
  • Never assume that stock market is for you only. Consider it like your employer who is going to pay you till you are going to put efforts. At every moment you have to compare your risk and reward ratio. This will make you realize that the rewards are higher when the market are at historic bottoms and the risks are higher when the market are making highs. And when the ratio starts turning towards risk, its time to exit.In Warren Buffet words - "Be greedy when other are frightened and get frightened when other become greedy"
  • Put Stop losses. It's important to cut down the losses before it becomes too big and also safeguard your profit to an extent. For example you have bought a stock at 25 and the stock goes to 100. Now put a strict stop loss say if it goes below 80 or 90 you are going to sell it now matter what happens. This is a discipline which needs to be inculcated.
  • Retail investor buy their stocks recommended by anyone in the street. The tips reaches to them when it would have lost its relevance and already has run up or down. Also the retail investor never bothers to understand the company behind the stock. It would be a good practice to at least verify the source of tip and at whether it still is relevant. A little bit of caution would help in safeguarding the profit as well as minimizing the losses.

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