Monday, 2 December 2013

Why do clever investors make big money mistakes?

Statistics show that most equity investors, including professionals, cannot beat the stock index. Studies have also shown that more than 80 per cent of day traders lose money mainly due to transaction costs as they select shares based on hot tips. There are several reasons for their poor performance but the most frequent mistake is ‘loss aversion’. This is a psychological obstacle which has been consistently affecting their performance, especially in view of the ups and downs that is the normal behaviour of the stock market. 

Loss Aversion - Some investors may object to the implication that loss aversion is a bad thing. After all, it is a very natural behaviour. They might justifiably point out that the tendency to weigh losses more heavily than gains is a net positive attitude. After all, investors who care too much about possible gains and too little about potential losses, run a great risk that can threaten their portfolios. It may appear better to care more about the share price falling than hoping for it to climb higher. 

True enough; loss aversion can be helpful and is part of a conservative strategy. But an over sensitivity to loss can also have negative consequences. One of the most obvious and most important areas in which loss aversion skews judgment is in selling too early and missing the additional profit if you dare to hold it longer. Very often even clever investors who are well versed in stock selection cannot overcome this psychological fear. 

What is tricky about this concept of loss aversion is that it can often lead us in the opposite direction- to hold on to a losing investment for longer than we should. I asked one of my friends why he sold a particular stock instead of selling his other holdings that he bought at higher prices? He said that he did not want to recognise the losses but preferred to lock in the profit. This is the most common mistake committed by investors because they do not want to admit their mistake of picking the wrong stock. Moreover, the profit from the sale could easily cover the losses. 

Studies have shown that on average, it is easier for well managed companies to continue their good performance than for bad companies to improve their poor position. That is why we should not sell good shares too early and retain the bad shares... ( read all if can, or the highlighted phrases. Good article )

It is the excerpts from Mr Koon Yew Yin @ ipohecho