MIAMI (MarketWatch) — Of all the mistakes I’ve made in the stock market, these three stood out.
1. Assuming you’re right
Of course everyone wants to be right. But the blind belief that you’re right about a stock can cost you money. I’ve been reading the best-selling book “The Big Short,” which profiles a handful of traders who were short subprime mortgages through credit-default swaps.
In 2007, certain bond traders concluded the mortgage market was on the verge of collapse. Before they placed their bets, two of these traders purposely searched for anyone with an opposing view. That’s right: They wanted to hear conflicting views before placing their trades. They were surprised that no one else in the industry seemed to detect the looming disaster. When the traders realized the counterargument was weak, they invested millions on short positions, betting against most of the large Wall Street bond firms.
I’ve always said that you should talk to short sellers if you want to hear the truth. Surrounding yourself with cheerleaders may feel good, but it won’t help you to detect potential land mines. No matter what your business, take the time to listen to other opinions.
Another strategy: Some traders enter a new trade assuming they are wrong. They enter the market as a pessimist, and let the facts guide them to the truth.
2. Not doing your research
To paraphrase Peter Lynch, people will spend two weeks researching a $500 refrigerator, but spend thousands on a stock without a second thought. Years ago, I invested $20,000 in a small cell-phone company based on a tip from an acquaintance. Within three months, I lost nearly $15,000. At the very least, I could have glanced at a chart or done basic fundamental analysis. For $300, I could have flown to the company’s headquarters. As it turned out, I blindly bought the pump-and-dump stock and paid the price.
Do you walk into a car dealership and pay list price? Hopefully not. Don’t expect guidance from the salespeople, who will gladly sell you a car for the highest price. When you’ve done your research, tips, hype or emotion won’t sway you.
Another lesson: Be wary of sources with ulterior motives. In “The Big Short,” the traders assumed that many bond salesmen were lying about subprime mortgages. To find out the truth, the traders spent hours reading mind-numbing contracts. They were surprised that few salespeople even knew what was in the contracts. The so-called experts were as clueless as the public.
3. Following the crowd
I’ve always been fascinated by crowd behavior. In 2006, when people were day-trading houses, few recognized they were on the edge of a cliff. The crowd was in a buying frenzy, and the stock market climbed along with housing.
If you look around and see everyone making the same trade as you, be cautious. Often the crowd is right, but only for a while. When people are making a lot of money, it’s easy to miss the warning signs.
Recently, the “crowd” has been in an ornery mood. Many experts are making wild doom-and-gloom predictions based on opinion and conjecture.
Before you sell all your stocks and hide in a cave, read what author and billionaire Ken Fisher told me for my book, “All About Market Indicators”: “When people approach me with predictions, I ask, ‘Has this happened a lot in history? What do you base that on?’ And if it never happened before in history, they are making a very strong statement. And if it has never happened before, you’d better have some powerful evidence to make me believe this event will happen. People tell me things all the time that are so improbable because they have happened so rarely in history. People who bet on the black swan will get their neck chipped.”
To avoid losing money, follow the three lessons above: Do your own research (and find evidence to support or disprove your view), don’t follow the crowd and listen to people with opposing views.
Michael Sincere is the author of Start Day Trading Now (Adams Media, 2011), All About Market Indicators (McGraw-Hill, 2010), and Understanding Stocks (McGraw-Hill, 2003).
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