During the current stock market crash, buying shares that are undervalued could be a good way to kickstart some profits. If you are starting out as an investor, there are plenty of great things you can do, but also plenty to avoid. Here are three of the most common mistakes I have seen (and even made myself).
Avoid excessive leverage
To generate a significant amount of profit, you need to have a large amount of initial investment to play with. But as most of us do not have millions to invest, this flags up a mistake to avoid. Resist the urge to invest with high leverage on borrowed money.
You may feel like it makes sense to borrow funds or multiply your trading capital via 100-to-1 leverage from stockbrokers. While it is true that this could help you make outsized profits, it also exacerbates your losses. At a time when the FTSE 100 index is swinging around several percent in a single day (both higher and lower), this is not a smart ploy. Even if you are correct in the long-term direction, you may be forced to sell the stock early to cover short-term losses.
Don’t go all in
You may have found a perfect stock that you have researched and believe is a sure winner. This is great, and I would encourage an investment in this firm. But I never put all of my eggs in one basket. Going all in and investing all your funds into one firm is a common mistake. The main risk here is that you have no diversification, and so are exposed 100% to systematic risk. This firm-specific risk basically means that something bad can happen to your individual firm, but not the market.
A simple way to reduce this firm-specific risk is to invest smaller amounts in multiple firms. If you own shares in 100 firms and one firm files for bankruptcy, diversification means this only has a small impact to your overall portfolio.
Invest, don’t trade
You may see adverts promoting short-term intraday trading ideas to make untold riches. It is a lot easier to make money by being invested for the long term than just a day. There are multiple economic theories to back this up, which I do not have space to go into here.
Some key concepts, though, are the value of compounding (which you get over time but not in a day). Another one is behavioural finance, in that we are tempted to sell a stock if it rallies 10% in a day, when in fact it could rally 100% over the next year.
In my experience, I leave trading for the small fraction of people who are geared up for it.
Hopefully, this article can help you avoid these three mistakes. It should enable you to enjoy a higher probability of making money from your stock investments, rather than falling flat on your face!
Jonathan Smith and The Motley Fool UK have no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.