Sometimes, investors make mistakes. After all, nobody’s perfect. Unfortunately, mistakes in the investing world can cost a lot of money.
When losing money on a trade, a small, one-time setback is easier to recover from than, say, several large, recurring losses. These large losses can prevent you from meeting your financial goals.
In many instances, however, these losses are a result of investing mistakes that could’ve been avoided.
In this article, we’ll identify three common pitfalls Johannesburg Stock Exchange investors often make and discuss ways to potentially steer clear of these mistakes.
1. Falling in love with a single stock
The first pitfall is falling in love with a single stock. This might sound funny, but some stocks form a cult-like following after a prolonged uptrend or as a result of a popular product or service.
The financial media often feeds into a stock frenzy by frequently highlighting price gains or touting a company’s product or service.
All this attention pushes the stock price higher. But during the frenzy, some investors lose sight of risk management. Inevitably the uptrend will end and the stock will reverse direction and head down.
When the downtrend begins, these investors can experience massive losses.
2. Disproportionate portfolio
The second pitfall investors commonly find themselves in is owning too much of a single stock through an employer-sponsored stock purchase plan or through employer-issued stock options.
If part of your compensation is company stock, then it can be easy to accumulate a large, concentrated stock position. However, this can increase the risk in a portfolio and lead to large losses if the employer’s stock trends lower.
Before we move on to the final pitfall, let’s discuss how you can possibly avoid making these two common mistakes. The solution is the same for both. Basically, it comes down to investing an appropriate amount in a single stock.
Whether it’s a stock you love or your employer’s stock, it’s important to maintain balance in your portfolio. The key is position sizing. This is the process of spreading a portfolio equally among individual stocks and occasionally rebalancing overweight positions.
Rebalancing involves taking partial profits in a stock that’s performed particularly well and then using the proceeds to reinvest in another stock. This way, you can still consider owning stock you love or your employer’s stock, but you also help reduce the risk to your portfolio by maintaining appropriately sized positions.
3. Unrealistic Expectations
Now on to the third common investing pitfall, setting unrealistic expectations. Sometimes investors start trading with the unrealistic expectation of making extraordinary returns like 50 or even 100% per year.
The truth is, these types of returns are very difficult to achieve consistently, if not impossible. Setting such unrealistic expectations can open the door to excessive risk taking.
Some investors might try to reach these unrealistic expectations by using a complex trading system without fully understanding how the system works. This can lead to unnecessary losses.
Another way investors fall into this trap is by acting on tips and rumors from friends, financial media, and the Internet.
Trading on tips alone usually leads to losses for most investors. Investors can help stay grounded by having realistic expectations. For example, stocks on the Johannesburg Stock Exchange have generally returned high single digits per year, such as 6 or 7%.
But these returns are not guaranteed. Stocks can lose money in any given year. Another way to try to avoid setting unrealistic expectations is to create and follow an investing plan.
An investing plan defines entry and exit rules and other factors that guide investment decisions. It’s much easier to be disciplined when you have an investing plan in place. You’re less likely to rely on complex strategies, tips, and rumors.
Following a plan that helps you steer clear of these common investor pitfalls might help you avoid large losses and keep your financial goals on target.