DIY-2 How (not) to lose money in the stock market
Anybody who is entering the equities market to invest is thinking of earning a lot of money, eventually, and there is a very good reason to believe that they would.
But many are forgetting the risks involved in the venture, which are really important, since remembering the risks can help them determine what to do while in the market.
One such risk is using the money that an investor might need to use on other things in the very near future. Like maybe for tuition fee of the kids or some unforeseen emergencies.
One of the rules in investing is to use only the money that you don’t need. This means, money that you won’t need even on above-mentioned emergencies (except probably for the ones of epic proportions, god forbid!)
Investments are supposed to be long term (as opposed to trading, which is short term). We are talking of an investing horizon here that lasts years and months. People who are holding stocks for short periods of time are called Traders not Investors.
There are good reasons why an investor has to stay long in the market. Many believe that the longer your money is invested, the bigger your chances of turning in profits and making those profits grow.
It also lessens the possibility of you wanting to desperately take your money out at the wrong time. Like, when the prices of your shares dip lower than your purchase prices which happens for just about any reason other than the ones you should be concerned with.
Just as any trader, you are supposed to buy your stocks at a lower price and sell them at a higher price. If you don’t need the money that you used to buy them for your immediate requirements you can let the money sit there till the prices recover or grow significantly higher, but if you used the money that you will need – say in the next few months, you may be forced to sell your stocks at a loss when the market dives right at the time when you need to take it out.
That is the surest way of losing money in the market.
Another reason that might force you to sell lower than your purchase price is fear. Fear that you might lose more of your money when the trend or general movement of the market is down, or simply for fear of the unknown. See, not because the prices go down for a while, they will continue to go down forever - just as rising prices will not go on rising forever.
But then, nobody really knows when the price is going to stop moving from its trajectory or reverse back to another direction.
You might think that the most dangerous time for your investments is when there is an economic crisis and when the market crashes. That is not necessarily true. You can suffer your worst losses even during normal times.
Don’t get me wrong, seeing your investments lose value fast during a market crash can be gut-wrenching. I went thru the 2008 crash and I know how it feels, but most of my positions in that crash recovered and went on to give me profits eventually. Stocks that were not sold only lost value on paper (if you go by mark to market valuation). You only truly lose that value on real money when you sold the stocks. It’s like selling them make your losses official.
In fact, there are studies that show that most markets dropped only by as much as 30-35% on the average in the worst market crashes and that when the market recovers it far exceeds those numbers.
There is another study that says that there have been more Bull Runs than there were Bear markets. I will leave it up to you my newbie friends to find out what bull markets and bear markets are because if you don't know yet what they mean, you shouldn’t be in the market yet - as you have not been reading enough, and you should. Books on investing abound. I am no expert, just sharing a bit of experience.
So, if the worst economic crisis and market crashes are not the most dangerous times for your money in the stock market, when is it more dangerous?
I have an answer to that question but I am just a newbie in this world too so, I suggest that you check the opinion of the experts.
My answer? Your money is at its utmost risk between the time you bought the shares of stocks of the wrong company and the time when you are not looking.
What do I mean by that? I mean, if you bought the shares of the wrong company, it would be like you are gambling. You will have to know when to get out in time with a profit or with the smallest loss possible.
To the prospective investors, however, who have the mistaken notion that the stock market is like a big gambling casino, allow me to share with you an explanation I gave to a friend who at one time was dissuading me from going into the market.
I told my friend that I’ve been to a casino, out of curiosity, a few times. I placed my bets in a card game and I played the slot machines. I won some but mostly I lost. I knew before entering the casino that the odds in a place like that are stacked against the gambler – the house always have the upper hand. There are times when a gambler will win big time but just like me, mostly they lose.
I didn’t find that surprising at all since in a casino it is quite obvious that the house has to lose if the gamblers have to win and vice versa. It is never possible for both the gamblers and the house to win at the same time. The house and the gamblers are always pitted against each other.
That is not quite the case with the stock market. The bourse is never pitted against the investors. In fact, in a bull market everybody wins. Add to that the fact that all the employees and officers working for a company, which shares you bought, are in effect, all working to make you win. That is, except in cases like Enron and/ or when you entrust your money with a Bernie Madoff.
The market is such that even the price of the shares of the wrong companies rise and fall just like all of the rest. If you bought the right ones, you can go to bed and sleep soundly at night. Confident that your money would still be there by the time you wake up. That may not be the case with the wrong ones. I know this well enough, as I still have some of the wrong stocks I bought when I was starting. Oh, sure, they are still there and while I am tempted to sell them at a loss, I cannot since there are no takers. Meaning, those stocks are no longer liquid. But that is not the worst. The really crazy thing about those wrong stocks is that they are now so worthless that if a buyer comes along, the money that I will get from selling them would be a lot less than the fee I will have to pay for the trades!
What about market crashes? Well, the market always recovers. It may take a little longer sometimes but it always recovers. Wrong companies sometimes never do. And when they don't then you lose everything you invested in them. I also had a stock like that. It just went poof! The company did not just drop out of the market, it dropped out of existence!
Oh, if it needed to be said... despite those few wrong choices, I am on the winning side. I read, I keep myself informed, I use logic (despite the illogical market), I have time and I always consider the risks.
If your investing horizon is not long enough for the current market, Mr. Benanke’s recent pronouncement on QE reduction might scare you into selling as the market is still going down. But it is crazy since the reason the Fed will reduce its $85-B monthly bond buying is because the Fed believes that the US economy is already improving. A good economy is good for stocks, right? Yet the market seems to be throwing away its early gains for the year.
But that is no reason to play chicken. A friend of mine once asked why I still have to put my hard earned money in harm’s way when I can just keep it somewhere safe. Well, because the truth of the matter is even the money kept in a safe (vault) is not safe. It inevitably will have some risks associated with it wherever you put it. You can lose it to a burglar or to inflation. Inflation is not even a crime, or a criminal, yet it is costing everybody money and there is no escaping it.