18 Common Mistakes Most Investors Make
taken from How to Make Money in Stocks, page 254-257
 
Author: William J. O'Neil
ISBN:   0-07-048059-1
Publisher:  McGraw-Hill, Inc.
Published: 1995

Knute Rockne, the famous Notre Dame football coach, used to say, "The way to succeed is to build up your weaknesses until they become your strengths". The reason the rank and file either lose money or achieve embarrassing results is because they simply make to many mistakes.

Over a period of 35 years, I have dealt with or known thousands of individual risk taker, all the way from green beginners and amateurs to the most knowledgeable and successful professionals. Following are the mistakes I have noticed made most frequently by individual investors who were not too successful.

1. Most investors never get past the starting gate because they do not use good selection criteria. They do not know what to look for to find a successful stock. Therefore, they buy fourth-rate "nothing-to-write-home-about" stocks that are not acting particularly well in the marketplace and are not real market leaders.

2. A good way to ensure miserable results is to buy on the way down in price; a declining stock seems a real bargain because it's cheaper than it was a few months earlier. For example, an acquaintance of mine bought International Harvester at $19 in March 1981 because it was down in price sharply and seemed a great bargain. This was his first investment, and he made the classic tyro's mistake. He bought a stock near its low for the year. As it turned out, the company was in serious trouble and was headed, at the time, for possible bankruptcy.

3. An even worse habit is to average down in your buying, rather than up. If you buy a stock at $40 and buy more at $30 and average out your cost at $35, you are following up your losers and mistakes by good money after bad. This amateur strategy can produce serious losses and weigh you down with a few big losers.

4. The public loves to buy cheap stocks selling at low prices per share. They incorrectly feel it's wiser to buy more of stock in round lots of 100 or 1000 shares, and this makes them feel better, perhaps more important. You would be better off buying 20 or 50 shares of higher-priced, sounder companies. You must thing in terms of dollars you are investing, not the number of shares you can buy. By the best merchandise available, not the poorest. The appeal of a $2, $5, or $10 stock seem irresistible. But most stock selling for $10 or lower are there because the companies have either been inferior in the past or have had something wrong with them recently. Stocks are like anything else. You can't buy the best quality at the cheapest price!

It usually costs more in commissions and markups to buy low-priced stock, and your risk is greater, since cheap stock can drop 15% to 20% faster than most higher-priced stocks. Professionals and institutions will not normally buy the $5 and $10 stocks, so you have a much poorer-grade following and support for these low-quality securities. As discussed earlier, institutional sponsorship is one of the ingredients needed to help propel a stock higher in price.

5. First-time speculator want to make a killing in the market. They want too much, too fast, without doing the necessary study and preparation or acquiring the essential methods and skills. They are looking for an easy way to make a quick buck without spending any time or effort really learning what they are doing.

6. Mainstream America delights in buying on tips, rumors, stories, and advisory service recommendations. In other words, they are willing to risk their hard earned money on what someone else says, rather than on knowing for sure what they are doing themselves. Most rumors are false, and even if a tip is correct, the stock ironically will, in many cases, go down in price.

7. Investors buy second-rate stocks because of dividends or low-price-earning ratios. Dividends are not as important as earnings per share; in fact the more a company pays in dividends, the weaker the company may be because it may have to pay high interest rates to replenish internally needed funds that were paid out in the form of dividends. An investor can lose the amount of dividend in one or two days' fluctuation in the price of the stock. A low P/E, of course, is probably low because the company's past record is inferior.

8. People buy  company names they are familiar with, names they know. Just because you used to work for General Motors doesn't make General Motors necessarily a good stock to buy. Many of the best investments will be newer names you won't know very well but could and should know if you would do a little studying and research.

9. Most investors are not able to find good information and advice. Many, if they had sound advice, would not recognize or follow it. The average friend, stockbroker, or advisory service could be source of losing advice. It is always the exceedingly small minority of your friends, brokers, or advisory services that are successful enough in the market themselves to merit your consideration. Outstanding stockbrokers or advisory services are no more frequent than are outstanding doctors, lawyers, or baseball players. Only one out of nine baseball players that sign professional contracts ever make it to the big leagues. And, of course, the majority of ball players that graduate college are not even good enough to sign a professional contract.

10. Over 98% of the masses are afraid to buy a stock that is beginning to go into new high ground, pricewise. It just seems too high to them. Personal feelings and opinions are far less accurate than markets.

11. The majority of unskilled investors stubbornly hold onto their losses when the losses are small and reasonable. They could get out cheaply, but being emotionally involved and human, they keep waiting and hoping until their loss gets much bigger and costs them dearly.

12. In similar vein, investors cash in small, easy-to-take profits and hold their losers. This tactics is exactly the opposite of correct investment procedure. Investors will sell a stock with a profit before they will sell one with a loss.

13. Individual investors worry too much about taxes and commissions. Your key objective should be to first make a net profit. Excessive worrying about taxes usually leads to unsound investments in the hope of achieving a tax shelter. At other times in the past, investors lost a good profit holding on too long, trying to get long term capital gain. Some investors, even erroneously, convince themselves they can't sell because of taxes - strong ego, weak judgment.

Commission costs of buying or selling stocks, especially through a discount broker, are relatively minor factor, compared to more important aspects such as making the right decisions in the first place and taking action when needed.

14. The multitude speculates in options too much because they think it is away to get rich quick. When they buy options, they incorrectly concentrate entirely in shorter-term, lower-priced options that involve greater volatility and risk rather than in longer-term options. The limited time period works against short-term option holder. Many options speculator are also write what s referred to as 'naked options' which are nothing but taking a great risk for a potentially small reward and, therefore, a relatively unsound investment procedure.

15. Novice investors like to put price limits on their buy-and-sell orders. They rarely place market orders. This procedure is poor because the investor is quibbling for eighths and quarters of a point, rather than emphasizing the more important and larger overall movement. Limit orders eventually result in your completely missing the market and not getting out of stocks that should be sold to avoid substantial losses.

16. Some investors have trouble making decisions to buy or sell. In other words, they vacillate and can't make up their minds. They are unsure because they really don't know what they are doing. They do not have a plan, a set of principles, or rules, to guide them and, therefore, are uncertain of what they should be doing.

17. Most investors cannot look at stocks objectively. They are always hoping and having favorites, and they rely on their hopes and personal opinions rather than paying attention to the opinion of the marketplace, which is more frequently right.

18. Investors are usually influenced by things that are not really crucial, such as stock splits, increased dividends, news announcements, and brokerage firm or advisory recommendations.

If you hunger to become a winning investor, read the above items over very carefully several time and be totally honest with yourself. How many of the habits mentioned above describe your investment beliefs and practices? As Rockne would say "These are the weaknesses which you must systematically work on until you can change and build them up into your strong points".

Poor principles and poor methods will yield poor results. Sound principles and sound methods will, in time, create sound results.