Investing is like car maintenance in some ways. Many people are content to leave it to the professionals, returning to a trusted mechanic at regular intervals; others prefer to get their hands dirty taking care of things for themselves. If you're that second type of person, the day will come when you decide you've outgrown mutual funds and want to invest directly in stocks. This is a laudable ambition, but there are a lot of stock-trading pitfalls to watch for.
Buy High, Sell Low
Everybody understands at some level that the fundamental goal of investing is to "Buy low, sell high." The thing nobody tells you is that it's supremely difficult to do when it's your own money. Emotions get in the way, and tell us to climb onto shooting-star stocks and sell off anything that's on its way down. Unfortunately, that means buying while they're high and selling while they're low. It's important to understand your investment goals and your investment timeframe. If you plan to hold a stock for decades, for instance, even a two or three year downturn in its value is only a speed bump.
Not Enough Capital
One of the key investing strategies is diversification: spreading your investment across a number of markets and sectors, so no one piece of your portfolio can hurt you badly. It's hard to do, if you haven't got enough money to take positions in 10 to 15 carefully chosen stocks or other investment products. When you're first starting out, equity-driven mutual funds are your best bet. You get a diversified portfolio from day one, even with $500. Otherwise, you're putting too many eggs in too few baskets. That's great if you choose Microsoft, but bad if it's Enron.
Skimping on Research
It's important to understand that buying stocks actually means becoming part-owner of a real, working business. It's a significant purchase, and like a car or a home, you should research it before you plunk down your money. Find out whether the company is successful and financially stable, and whether the management team who made it that way are still in place. Learn the importance of key ratios, such as price-to-earnings and return-on-equity, so you can judge whether a company is trading above, below or at its value. Keep up on the news, so you'll know whether their region, or their industry, is in trouble.
Remember, just because short-term stock investing is called "day trading" doesn't necessarily mean you have to make trades every day. Even if you're doing your own trading rather than using a broker, there are costs associated with each and every transaction. If you're constantly turning over stocks in search of a quick profit or a quick escape from a losing investment, you're generating fees that will sap the life out of your returns. They're small but they add up, just like extra minute or data charges on your cell phone. Remember that first cell phone bill, the one that was more than you made in a month?
Lack of Commitment
Here's the big one that lurks beneath most other trading pitfalls. If you're serious about investing directly, you've really got to commit to it. You've got to follow the markets, follow the news and follow whole industries, not just the ticker for your little handful of stocks. It takes a lot of time and effort to do it right, which is why so many people leave it in the hands of brokers. If you're a buy-and-hold investor, who plans to keep a consistent portfolio for the long term, you probably only need to review your holdings quarterly. However, day trading is a time commitment comparable to your full-time job.
Fred Decker is a trained chef and certified food-safety trainer. Decker wrote for the Saint John, New Brunswick Telegraph-Journal, and has been published in Canada's Hospitality and Foodservice magazine. He's held positions selling computers, insurance and mutual funds, and was educated at Memorial University of Newfoundland and the Northern Alberta Institute of Technology.