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Investing in the stock market: Ten mistakes to avoid

25 October 2017 by National Bank
mistakes to avoid in stock market

It is not uncommon for investors to make the same mistakes. Here are 10 to avoid when you invest in the stock market.

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Not having the right knowledge and tools

To take care of your investments, professionals are required by law to have the necessary knowledge and permits. Legally, any individual can decide to invest in the stock market with their own money. People often make their first investment on the advice of a friend or colleague, and start buying securities because they believe they will perform well or because they've heard people talk about them. Unfortunately, the results usually do not live up to expectations. Technical analysis can be an extremely useful tool for independent investors, helping them choose the right securities and identify the best moments to buy or sell.

Investing over the short term and relying solely on basic information

Of course, basic financial information has value. But it's not easy to know the best move without applying technical analysis. Stock prices can change for a host of reasons that don't involve information about the company. Certain factors can influence most stocks in a given industry sector. For example, a major swing in gas prices or in the value of the greenback could affect most stocks in the Energy sector. Another example: When Amazon acquired Whole Foods, stocks of major food retailers in the U.S. and Canada fell. Simple, effective technical analysis software can help you easily monitor your positions and pinpoint any factors that could influence your investments.

Buying shares on a downtrend

The word "trend" has a specific meaning when it comes to investing on the stock market, and refers to trend lines—which are revealed by examining stock charts for market cycles. By tracing one line between market cycle peaks and another between the valleys, we can pick out ascending and descending trend channels. It is always riskier to buy a stock that falls below the descending trend line, even if stock prices are going up.

Trading in illiquid stocks

Liquidity is determined by the number of transactions carried out and the number of shares traded. A stock with a low trading volume will have an erratic stock market chart, with frequent discrepancies between the asking price and the bidding price. These stocks are more susceptible to price manipulation. You will probably buy shares at a number of different prices, due to a lack of sellers at your price point. We don't recommend trading in stocks with a daily trading volume below several hundred million shares.

Failing to consider trading volumes

Variations in trading volume are very important. However, many investors lack the knowledge or the tools needed to analyze these variations. It's important to understand that many kinds of transactions are included in the trading volumes published by stock markets. These include share issues, transfers between companies (inventory movements), and scheduled, fixed-price trades, as well as all shares bought and sold during the normal trading day. The large volumes generated by inventory movements and the issuance of shares or stock warrants can muddy the waters. By using electronic tools, you can narrow it down to the "true volume," i.e., the trades that can be used to extrapolate trends.

Failing to invest in new sectors with high potential

From time to time, industry sectors with high potential pop up or become more prominent as a result of major societal change or new technology. These sectors may start off with low potential—but sometimes they can grow exponentially. A given industry can become trendy without necessarily generating stock market buzz. Nanotechnology has not had great success on the markets, as it is still too experimental. An increase in demand for diamonds only benefits a few companies, as they are too rare, too difficult to mine and too expensive. But the graphite and lithium production sector, fuelled by the race to build electric cars, is deemed to have a great deal of potential. The cannabis sector has also grown rapidly, as a result of the movement to legalize the substance. This sector could remain an interesting investment for some time to come.

Waiting too long to invest

Buying stock is not complicated. The first day of a new bull cycle, marking the start of a new upward trend, is definitely the best time to buy. You need to learn to act quickly, when the first stocks in a given sector start showing buy signals. Most of the time, people invest at the wrong time because they let themselves be guided by their emotions. When they see several stocks increasing in value over a number of days, they end up getting scared they're going to miss the boat—when in reality, they should wait to take action at the start of the next cycle.

Failing to secure your positions

Securing a position involves selling a portion of your shares to bring down your cost price and free up funds, thus minimizing losses while maximizing profits. Most investors sell stocks rarely; when they do, it's often out of frustration, and far too late. Formerly, securing positions was not a practical strategy over the short term, because each trade could cost hundreds of dollars. Today, the cost of trading has gone way down. Some trades are even free—including all Canadian and U.S. ETFs traded at National Bank Direct Brokerage.

Hanging onto stocks well past their sell-by point

When new investors first enter the stock market, they tend to go for companies that are well-known and popular, rather than picking companies and sectors that are expanding. In the past, Bombardier was one of the best buys available. Some investors were able to build up a small fortune in Bombardier stock—but now the situation has changed. Investors are still hanging on to shares that they bought between $20 and $25, but stock prices have dipped below $1 several times and are currently hovering around $2. Another situation we can consider is Air Canada's filing for bankruptcy protection in 2003, where investors lost everything (although Air Canada stock is now performing better than ever). Remember Steinberg, Nortel, Bre-X, Canada Lithium and Orbit: When you play the markets, you need to be willing to let go.

Not having an exit strategy to limit losses and maximize profits

When you decide to buy stock, you need to have a plan. You need a growth objective to make sure you buy at the right time to make a profit and secure your position, as well as an exit strategy to limit your losses if stock prices fall. You'll need to learn about investing and have the right research and analytical tools—but the key thing is to have a game plan and to stick to it.

N.B.: Don't miss the free interactive live presentation put on by National Bank Direct Brokerage and decisionplus.com this November 7. NBDB will present its research, analytical and advisory products. The event is an opportunity to build your investment knowledge and take advantage of a great introductory offer from National Bank Direct Brokerage.

 

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