Mark Ford, creator of the Early To Rise website enumerates 5 common biggest mistakes investor make. It's a very practical and insightful list.
1.Being swept away by exciting stories.The business my boss got suckered into had an amazing story. A company in Central America was turning beach sand into gold. The company had “proof” of their success—in the form of audited financial statements, geologist reports, and endorsements from investment experts. My partner even went down there to see the operation. He saw the sand going in and the gold dust coming out. I didn’t invest because the story sounded so fantastic. I remember telling him, “This sounds like alchemy.” I didn’t know anything about geology or gold, but I didn’t need to. The story itself was just too crazy. When I hear stories like that nowadays, I’m totally turned off. One part of my brain might get excited, but the smarter part tells me, “Stay clear!”
My comment: In momentum trading, exciting stories are frequently rationalized to feed on a momentum dynamics. "Exciting" stories, which are attempts to reason from price changes, are therefore, based on fallacies (anchoring, survival bias and post hoc).
Moreover, in order to exacerbate developing hysteria, establishment institutions capitalize on this by dishing out even more literatures to feed on the progressing rage.
For the establishment, more churning more fees and commission. For the gullible audience, more excitement equals more risks.
Yet excitement and boring marks a crucial sentiment in investing success, as George Soros rightly points out,
“If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.”
2. Investing in businesses you don’t understand. My boss was a sophisticated investor. He had his own seat on the stock exchange when he was in his 20s and had been successfully investing since that time. But he knew nothing about gold mining. His ignorance allowed him to be duped by the reports and by the fraudulent factory tour. The scam was exposed by a few people in the mining business. They understood the industry and knew how to read reports with the sophistication of experience. If you don’t understand the business you’re investing in, you’re investing blind.
My comment: This is a very common mistake especially applied to stock market retail participants (neophyte or even the veterans).
These people read documents issued by the establishment whereby they come to perceive themselves as already "knowing" or "understanding" the business. In addition, as price movements coincide with their biases, the belief that they have acquired sufficient knowledge is reinforced. So with comfort zones established, this motivates them to stop learning.
In reality, related to or connected with "exciting stories", most of retail investors are provided with superficial information that has designed to encourage "momentum" and short term price chasing actions. Dominant institutional literatures hardly delve with the tradeoff between risk and return in the context of probability-payoff. For the consensus, emotion is equivalent to investment and prosperity.
3. Allowing yourself to be bullied by good salespeople.I mentioned I made some bad investments early in my real estate career. They were due to a combination of the two mistakes I just enumerated. Plus, I buckled under pressure from a real estate broker who also happened to be my landlord and—I thought—my friend. I agreed to make the investments even though I had a hunch they wouldn’t work out. I ignored my instincts because she was so good at manipulating my emotions. Nowadays, whenever someone tries hard to sell me something, I take that hard selling to be a signal: Stay away!
My comment: Again, the agency problem or conflict of interest between industry people and their clients are pronounced in the financial industry. That's because of the incentives guiding industry people (fees and commissions) are different from the incentives by their clients (profit and loss from trade). Industry people use asymmetric information such as technical insights as sales pitches which they benefit from rather than their clients. Because the audience is usually overwhelmed by "technical gobbledygook" mostly founded on statistics, they buy such hokums.
The conversation in this video from a scene on the Wolf of Wall Street is very relevant. Mark Hanna mentor of Wolf of Wall Street Jordan Belfort talks about selling fugazi--fake world or selling hope to screw the clients
4. Investing in trends too late — when the only chance of making money is to find “the bigger fool.” I got into real estate investing at a good time, when prices were already going up but the values were still good. I made a lot of money as the market rose. When I could no longer buy properties at eight or 10 times yearly rentals, I realized the only way to profit was to ride the bubble to the top. But riding a bubble when the economics are bad is a fool’s game. Your only chance of winning is to find someone else willing to buy you out… someone who knows less about the market than you do. Insiders call this “the bigger fool theory.” You’d think anybody with common sense wouldn’t fall victim to this impulse. But millions of Americans (including bankers and brokers) did. There’s a time to get into a trend and a time to get out. Neither is that difficult… so long as you pay attention to the fundamental economics of the deal and ignore the excitement caused by the bubble.
My comment: all of the above four are interconnected, interrelated and or entwined. The bigger the mania, the more vociferous the establishment sales pitches and the more intense the belief of one way trades.
Here, taking an opposite position from mainstream beliefs can make one lose friends! That's how passionate convictions have become! Yet religion like fanaticism and dogmatism characterizes market inflection points!
5.Investing without a way to limit your losses.Sometimes, even if you use your common sense—and avoid the four mistakes I’ve already explained—you can lose money because something unpredictable happens. To avoid this, I have a rule: I never get into an investment unless I have a way out. When you’re investing in a business deal, that “way out” might be a buy/sell agreement. When you’re investing in real estate, the way out is the income you can get from renting it if you can’t sell it for any reason. When you’re investing in stocks for yearly gains or income, the way out is the trailing stop loss. There is always a way to limit your downside as long as you identify what that is before you make the investment—and stick to it. Even if you feel like you shouldn’t.
My comment. During manias, the greater the hope, the bigger the positions. I have seen some who are fully invested at market tops.
And most of these positions have been intended to maximize exposure from a perceived one way direction. Hence, such positioning translates to little or no margin of safety or cushion for error. So when things get out of whack, participants become lost on how to deal with mounting losses. One way street thinking will lead to the utter destruction of a portfolio. Leverage will even amplify this.
Realize that it is not a problem to participate in a mania. This is for as long as the portfolio is designed for contingencies. Such would come in the form of asset distribution share of balance sheet allocation, position sizing and trailing stop losses. Yet these are just tools to attain an end.
In short, self-discipline ultimately determines one's success and failure in surfing the market cycles.
Apply the opposite during depressions.
As a Wall Street saw goes, "Bulls Make Money, Bears Make Money, Pigs Get Slaughtered"
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