Everyone, from new investors to seasoned pros, make mistakes when investing. Losing money at times it a part of investing. Some lessons individuals will not believe, no matter how many times they are told, until they personally lose money. I call this “paying tuition to the market.” Other people might call it “stupid tax.” Whatever you decide to call it. An individual with the right temperament for investing will accept these mistakes, learn from them, dust himself off, and then move on.
I have taken my personal share of losses and made my share of mistakes. As I’ve said, some things you cannot learn without losing money personally, but maybe some of my readers out there will take these lessons to heart and therefore not need to lose money-making the same mistakes I did.
1) Stocks will go down and stay down much longer than you will expect them to. At times I’ve had a great stock that I was following fall out of the sky. Sometimes I have rushed in to buy shares, thinking that there was no way that they could go lower. Some of these times the stock dropped to an even lower price and then sat there for years. The lesson to learn here is that stocks do not fall for no reason. Just because you may not see the immediate cause does not mean that the whole world except for you has had a momentary lapse of judgment. A stock may have had a great quarter but issued guidance that future sales may slow. There may be some shenanigans going on at the company that you have not heard about. Markets tend to be very good at setting prices based on current news. If one of your favorites tumbles, even if the price seems unbelievable, it is best to give it a little while to wait for the other shoe to drop. If you must buy in, buy about half as many shares as you are planning to buy so that you can buy more later if prices continue to drop.
2) Stocks will stay up far, far longer than you expect them to. It is amazing how some of the Wall Street Darlings, for example, Krispy Kream, Outback Steakhouse, and more recently, Google, can rise to astronomical prices. Then, when you think that they can rise no more, they continue to rise higher. Even worse, in cases like Snapple or AOL, they are bought out by another company for those astronomical prices and then give the company that bought them out heart burn. Always be careful when looking to short stocks. Just because the price is high does not meant that the price cannot go higher. I was short Golden West financial in 2008. Then, just before the mortgage bubble began to burst, they were bought out, causing me to lose about $10 per share in one day. The fact that the company that bought them out later regretted the decision was of little solace to me since I’d already realized the loss.
3) To make $1 million in options, start with $10 million. Buying options is for the stupid. I repeat, buying and selling options is for the stupid – you will lose your money. In college I thought I could play the options game. I took up positions in equity options and index options. Within three months I had lost all that i intended to risk and about 4 times more! In buying options, the odds are stacked against you because you do not only need to be right about the direction, but also the timing. Even when you are right the spreads and commissions will kill you. Every time you make money the fees reduce your winnings. Every time you lose money the add to your losses. If you want to gamble, head to Vegas. At least you’ll get free drinks.
4) Never buy stock in a buy-out candidate. I bought shares of a stock called stop-and-go back in the 80’s, hearing that they might be bought out. Sure enough, a buy-out was announced — for $2 per share less than I had paid! Once the rumors are flying, you will be too late to get in at a decent price. Find some other stock to buy.
5) When management changes in a long-term successful company, watch out. Citizen’s utilities (now citizen’s communications) was once an untouchable company. They owned all of the utilities (telephone, water, electricity, waste water) for rural communities all over Arizona. The company had not missed increasing earnings for a quarter for decades. A person who had bought 1000 shares in the 1970’s would be a millionaire by the 1990’s. Then, management changed and an individual who was fond of starting telecom companies was installed as CEO. He changed the character of the company into that of a wireless phone company, sold off the other assets, and the steady earnings increases stopped. At that point the stock price, which would go up and split like clock-work, stalled and dropped by 50%. Whenever a company that has done well under a certain manager or groups, it is generally a good idea to think seriously about leaving if that manager departs.
6) If you’ve got a profit and are ready to sell, sell — don’t fool around. It was around 2000 and we were caught up in the middle of the dot-com bubble. I had purchased shares of a small internet company at $4 per share and seen the shares climb up over $20 per share in a short period of time. I was reading the yearly report at the airport and the realization came to me — this was just a pile of fluff and marketing. There was nothing of substance there. I called my broker from a pay phone. The stock had dropped a couple of dollars from its high, but I figured it would return so I set a limit near the old high. The stock never returned and proceeded to fall through the ether. If I had simply put in a market order I would have been out. As it was I don’t remember if I even made a profit.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.