Wednesday, February 17, 2016

How to lose money in the stock market

There is no doubt that despite the ups and downs of the stock market, it is one of the best way to build wealth over the long-term. Fidelity recently conducted a study as to which accounts had performed the best. What they found interestingly, was that they were dead or had forgotten they had an account at Fidelity! In essence, if you want good investment performance, forget you have an account.

If it is this simple, why does the average investor fare so poorly? It almost always comes down to the fact that our minds work against us. Nothing gets in the way of returns like someone who thinks they can beat the market with a great idea. These 3 mistakes are the most common that new and experienced investors make when it comes to investing and sure-fire ways to lose your money in the stock market.

Mistake 1 – Day Trading. Many believe that buying and selling stocks within a trading day is an easy way to make big profits through small intraday price movements. According to a recent study, over 90% of day traders lose money with the rest breaking even. Only a very small percentage make enough money to do it full-time. Why? Day trading is expensive. If you make 20 round-trip trades a day over the 250 trading days in a year, that will be 5,000 total trades, or 10,000 individual buy and sell trades. If you pay $10 per trade, that is $100,000 in commissions! So even if you make $100,000 in profit day trading, it will all go to commissions! Trading is a zero-sum game. This means that in every trade between two parties, one will win and the other will lose. Professional investment firms have spent millions of dollars to install cables to make their trades nanoseconds faster. Why? By doing this they have a leg up in trading, called “high-frequency trades”, to take advantage of the trends. The odds are stacked against day traders. It is better to leave the trading to professionals and be an investor.

Mistake 2 – Option Speculating. Options can be easy to learn by very difficult to master and extremely risky. Options are also known as derivatives since it “derives” it value from something else. An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an asset at a specific price on a certain date. Using options in a conservative can potentially provide some downside protection and produce a stream of income. However many try to speculate with options in hopes of making lots of money in short period of time. In every situation that I have dealt with, the investor using options instead has lost everything. As I mentioned in mistake 1, investing is zero-sum, so chances are the person on the other side of the options trade is much more experienced. Is there potential to make tons of money? Sure. Is it likely? Not at all.

Mistake 3 – Buying Penny Stocks. I constantly see all kinds of advertisements about how penny stocks can guarantee 500% returns on a penny stock. While there have been some penny stocks have hit it big, it is very rare. Many of these recommended penny stocks trade for as little as $0.0001 per share and the company recommending it look to pump then dump the stock. Some companies will even pay PR firms and analysts to cover it to make it legitimate and when unsuspecting investors take the bait, the company walks away with a nice profit. Anyone heard of the movie “The Wolf of Wall Street?” Perfect example.

Investors lose money when they try to make a quick buck or let their emotions gets the best of them. Building long-term and stable wealth takes time. If it sounds too good to be true, chances are it is!

-- Midweek, February 10, 2016

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