Most investors do not make any money in the stock market because they buy stocks at the wrong time. But how is it possible that most people end up buying stocks at exactly the wrong time? Let’s understand how the stock market is designed to trick most investors into forcing them to buy at the wrong time. But first, let’s understand the simple 3 step process of buying a stock.
The process of buying a stock
Step 1 : Find out a company
The very first step to buy a company’s stock is to find out that a company/stock exists in the stock market. This is where the market’s trap begins. Most investors do minimal research about the stocks & look at the current best performing stocks i.e. the hot stocks which everyone is talking about. This means that only a small portion of stocks get highlighted to the investors which are getting good publicity in the news channels due to some corporate actions or great recent returns. Investors get interested as soon as they see claims like “This stock has given a 100% return in 2 months” or “This company is going to have a merger!”.
On the other hand, there are many other companies with stable business and decent valuations which are not under the radar of most investors. Such companies are under the accumulation of smart players who want to gather as much stock as possible before the news breaks out. Most investors end up finding out about such stocks once they have already given multifold returns.
In a nutshell, only the hot stocks get highlighted to new investors whereas other stocks stay hidden even if they are as good (if not better) than the hot stocks!
Step 2 : Study about the company
Once a stock has been identified, the next step involves a thorough study about the company behind the stock. This study can be performed through fundamental analysis or technical analysis. However, most investors do not give much attention to the stock chart or the balance sheet of the company. Instead, they focus more on the hype around the stock which is a big mistake! Reading about the latest news in the company or the crazy returns which the stock has provided does not provide any meaningful information for investment into the stock. In fact, most hot stocks have great news supporting them, but that doesn’t make them a good investment.
The study of the company should be solely focused on the value of the company vs stock price (in fundamental analysis) or stock charts (in technical analysis). Focusing too much on the good news surrounding a company is almost always a bad idea! To learn more, visit this article – Why news based trading leads to losses?
Step 3 : Buy the stock
Once the identification & the study of the stock is completed, the only step left is the process of buying the stock. This is always the easiest step with not much thought involved (or required) by the investor. The only thing which an investor needs to take care of while buying the stock is to ensure that he/she doesn’t have too much capital tied to any single asset. To learn more, visit this article – Why diversification is important for an investor?
The biggest mistake which most investors make during their stock buying process is that they focus only on the hot stocks which are highlighted to them! Also, they focus only on the news surrounding the stock or are amazed by the awesome returns which the stock has provided in the recent past. Not much thought is given to the actual study of the company.
But what’s wrong with buying hot stocks?
Hot stocks are the stocks which are known to everyone due to the high amount of publicity which they receive. There are generally two reasons why some stocks become the talk of the town.
- The stock has delivered amazing returns in the recent past
You must have heard about such stocks in the news. These are the stocks which grow 100 or 200% in a month & are suddenly everyone’s favourite stocks! Everyone wants to double their money as quickly as possible. However, what most investors forget while investing in such stocks is that they are taking up a huge risk! A stock which has already moved up a lot increases the risk & reduces the reward to risk ratio of the stock. Also, stocks which have risen a lot in the recent past become a great profit booking target for smart players. Thus, the stock gets simply handed over to the novice investors by smart players who end up losing money by buying the hype!
- The stock has some amazing corporate event / news behind it
Stock split, bonus shares, acquisitions, demergers, entry into a new business segment, you name it! Such kind of news is enough to send all investors into a buying frenzy while throwing all of the caution out of the window. Buying a stock at a higher price even after a good news is a risky bet because most smart players buy the stock well in advance of the good news. When the retail investors enter such a stock, the smart players tend to sell it off & book their profits.
What can investors do to avoid such mistakes?
Investors should only focus on the fundamentals and/or technicals of the company rather than focusing on the news or the recent stock returns. Avoiding all of the noise which distracts the investors from properly evaluating the company is the easiest method to find good companies. Typically, good companies compound slowly over years & do not provide very high returns over a short period. Remember, that the companies which provide quick returns over a short duration tend to be risky bets & end up falling a lot during their correction! Avoid all the market noise (news, hype, corporate events, etc.) & only focus on the fundamentals of the company or the technicals of the stock price.
However, the final decision of investing depends entirely upon the reader. If you liked this article, share & subscribe to this website! Follow us on Twitter for quick notification!
DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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