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Wednesday, September 26, 2007

Mental Mistakes in Stock Markets

Stock indices have had a huge run-up recently.The price rise has been particularly sharp in the midcap segment,i.e,in stocks that have a low capital base and relatively low liquidity.It may be the time to step back a bit,book profits and look for fresh oppurtunities in attractively valued stocks that have not participated fully in the rally so far.Profit booking is the key to succesful investing in bull markets.Those investors who books profits regularly have a higher risk taking ability as they can afford to invest in stocks where others have not moved in yet.Over-owned stocks pose a higher risk of loss when the markets turn down.

There are so many common mental mistakes investors make,that often lead to losses.Some of these avoidable errors are:-

1)Overconfidence-This can lead to complacency and over exposure.It is the most common mistakes investors make when they are making profits.In equities you can never throw caution to winds.

2)Herd-like behaviour driven by a desire to be part of the crowd or an assumption that the crowd is right-If midcaps are rising people buy these stocks without even knowing anything about the companies.There are so many companies in our markets which only exists on paper,they moves with the winds or faces some unscrulpous activites,the simple gullible investors gets in at the top and that leads to a paralysis when the price suddenly falls and as soon as that happens you are stuck badly unable to take a call on the stock.

3)Excessive aversion to loss=Inability to book a loss when an investment goes wrong is the single biggest cause for losses to investors.Unless a stock has been bought on strong conviction of long term value,those who make investments for quick gains must learn to exercise stoploss.

4)Fear of uncertainity-This leads to inaction.If we book profits and the stock still moves higher,we feel bad.Therefore if a stock is moving up most investors refuse to book gains.And many a time this ultimately leads to losses.

5)Fear of making an incorrect decision and feeling stupid-This too leads to inaction.People often opt for inaction when faced with fear of making a wrong choice.However little do they realise that not acting in time too is a choice that they made unknowingly.

6)Reluctance to admit mistakes-This is another behaviourial pattern that leads to incorrect decisions.In markets,we are loathe to admit that we made a wrong decision.However admitting a mistake and taking corrective measures often saves a lot of money.

7)Following tips of self-proclaimed advisors aware of nothing-I must admit that am a 19 year old lad who has been very fortunate to witness the either side of the markets.In a bull market so many self proclaimed analyst grows,they wud just name the company backed by nothing,the scrip moves up 10% and bang he is the next big bull that we all are looking for.This is another classical behavioural patern.Now simple investors would opt for that scrip without having any confidence or conviction and as soon as the price falls down,the villain is there to catch hold of.

8)Exiting out great scrips at lower levels and buying companies which exists on paper at highs-I get a lot of mails in my mailbox daily pertaining to these point,Arunji i entered your suggested great multibagger at these levels, it came down 20% from my level, so in fear i sold out,now it has more than doubled/tripled what to do?Buying into a scrip means you are actually buying a business.Its so hard to start a business and to run it,i mean just feel it, u have to have an office,plants,machiniries,employees so many hassles.But buying a single scrip of any company means you are the owner of a great business.That company is liable to share everything with you,you being the owner of that firm.But investors hardly cares about it..Do u?

9)Failing to accurately assess their investment time horizion-Most investors make investments for the short term but when the trade turns into a loss,they stick to it claiming that it was a long term call.This could often lead to huge losses.

10)Forgetting the powerful tendency of regression to the mean-This is the most important lesson for all investors.All stock prices must ultimately revert to their long term averages.All sharp run ups on dubious companies comes to an end in an most unpleasant manner.

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