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3 Common Stock Investing Mistakes You Should Avoid
By James Woolley
Stock market is a very dangerous game, particular if you are an inexperienced investor. If you are not careful you can very easily see your capital erode very quickly. So with that in mind, I want to discuss three common mistakes that you should avoid if you are new to stock market investing.
1. in small-cap companies.
I have been buying and selling shares for several years now but it still amazes me that so many amateur investors throw all of their cash into small-cap companies looking for the next five-bagger or ten-bagger. They will read through various stock market forums and will be encouraged to buy into these tiny companies that are tipped to be the next big thing, but most of them will ultimately fail, so it's basically just gambling.
A much better strategy is to stick to the consistently profitable large-cap companies initially, and preferably those that have a long record of delivering growth in both earnings and dividends. Then once you are more experienced you could then start thinking about diversifying your portfolio to include a small percentage of small-cap companies as well, if you so wish. There's nothing wrong with having a few high-risk investments in your portfolio as long as the rest of your portfolio is made up of more secure investments.
2. Having an unbalanced portfolio.
This follows on from the last point in that you should never spread yourself too
thin. In other words you should never invest all your money into just one or two companies, and you should try to invest your money across companies in a number of different sectors if you can to spread your risk. Failure to do so may leave you overexposed and it could have a disastrous effect on your portfolio if the sector you are invested in, or the handful of companies you are invested in, goes down.
3. in shares without using a stop loss.
One of the most common mistakes made by inexperienced investors is that they stubbornly refuse to use a stop loss. Now there may be an argument for saying that you don't need a stop loss if you are Warren Buffet-style with a ten or twenty year outlook, but in most cases you should stick to a stop loss to contain your losses.
Just look at Northern Rock or any of the other UK banks for instance. If you had invested in these companies a year or two ago, you would have seen your investments reduced to pretty much nothing, but if you had used a stop loss of say 10% or 20% then you would have been automatically stopped out a long time ago and most of your capital would now be intact.
So hopefully you can see the importance of diversifying your portfolio and preserving your capital. Timing is everything when it comes to stock market investing, but capital preservation and diversification are just as important, as I have hopefully demonstrated in this article.
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