Ignorance may be bliss, but not knowing why your stocks are failing and money is disappearing from your pockets is a long way from paradise. In this article, we'll uncover some of the more common investing faux pas, as well as provide you with suggestions on how to avoid them.

Tutorial: Major Investment Industries

1. Ignoring Catalysts
The financial pundits, trade journals and business schools teach that proper valuation is the key to stock selection. This is only half of the picture because calculating P/E ratios and running cash flow spreadsheets can only show where a company is at a given point in time - it cannot tell us where it is heading.

Therefore, in addition to a quantitative evaluation of a company, you must also do a qualitative study so that you can determine which catalysts will drive earnings going forward.

Some good questions to ask yourself include:

  • Is the company about to acquire a very profitable enterprise?
  • Is a potential blockbuster product about to be launched?
  • Are economies of scale being realized at the company's new plant and are margins about to rise dramatically?
  • What will drive earnings and the stock price going forward?

2. Catching the Falling Knife
Investors love to buy companies on the cheap, but far too often, investors buy in before all of the bad news is out in the public domain, and/or before the stock stops its free fall. Remember, new lows in a company's share price often beget further new lows as investors see the shares dropping, become disheartened and then sell their shares. Waiting until the selling pressure has subsided is almost always your best bet to avoid getting cut on a falling knife stock. (To learn more, read How Investors Often Cause The Market's Problems.)

3. Failing to Consider Macroeconomic Variables
You have found a company you want to invest in. Its valuation is superior to that of its peers. It has several new products that are about to be launched, and sales could skyrocket. Even the insiders are buying the stock, which bolsters your confidence all the more.

But if you haven't considered the current macroeconomic conditions, such as unemployment and inflation, and how they might impact the sector you are invested in, you've made a fatal mistake!

Keep in mind that a retailer or electronics manufacturer is subject to a number of factors beyond its control that could adversely impact the share price. Things to consider are oil prices, labor costs, scarcity of raw materials, strikes, interest rate fluctuations and consumer spending. (For more on these factors, see Macroeconomic Analysis and Where Top Down Meets Bottom Up.)

4. Forgetting About Dilution
Be on the lookout for companies that are continuously issuing millions of shares and causing dilution, or those that have issued convertible debt. Convertible debt may be converted by the holder into common shares at a set price. Conversion will result in a lower value of holdings for existing shareholders.

A better idea is to seek companies that are repurchasing stock and therefore reducing the number of shares outstanding. This process increases earnings per share (EPS) and it tells investors that the company feels that there is no better investment than their own company at the moment. (You can read more about buybacks in A Breakdown Of Stock Buybacks.)

5. Not Recognizing Seasonal Fluctuations
You can't fight the Fed. By that same token, you can't expect that your shares will appreciate even if the company's shares are widely traded in high volumes. The fact is that many companies (such as retailers) go through boom and bust cycles year in and year out. Luckily, these cycles are fairly predictable, so do yourself a favor and look at a five-year chart before buying shares in a company. Does the stock typically wane during a particular part of the year and then pick up during others? If so, consider timing your purchase or sale accordingly. (To learn more, see Capitalizing On Seasonal Effects.)

6. Missing Sector Trends
Some stocks do buck the larger trend; however, this behavior usually occurs because there is some huge catalyst that propels the stock either higher or lower. For the most part, companies trade in relative parity to their peers. This keeps their stock price movements within a trading band or range. Keep this in mind as you consider your entry/exit points in a stock.

Also, if you own stock in a semiconductor company (for example), understand that if other semiconductor companies are experiencing certain problems, your company will too. The same is true if the situation was reversed, and positive news hit the industry.

7. Avoiding Technical Trends
Many people shy away from technical analysis, but you don't have to be a chartist to be able to identify certain technical trends. A simple graph depicting 50-day and 200-day moving averages as well as daily closing prices can give investors a good picture of where a stock is headed. (To learn about this method, read the Basics Of Technical Analysis.)

Be wary of companies that trade and/or close below those averages. It usually means the shares will go lower. The same can be said to the upside. Also remember that as volume trails off, the stock price typically follows suit.

Lastly, look for general trends. Has the stock been under accumulation or distribution over the past year? In other words, is the price gradually moving up, or down? This is simple information that can be gleaned from a chart. It is truly surprising that most investors don't take advantage of these simple and accessible tools.

The Bottom line
There are a myriad of mistakes that investors can and do make. These are simply some of the more common ones. In any case, it pays to think about factors beyond what will propel the stock you own higher. A stock's past and expected performance in comparison to its peers, as well as its performance when subjected to economic conditions that may impact the company, are some other factors to consider.

To read about more investor follies, check out Seven Common Investor Mistakes, Learning From Others' Mistakes and Seven Common Financial Mistakes.

Related Articles
  1. Investing

    The Three Things Most Good Stocks Have In Common

    Uncover the three things most good stocks have in common: performance, profitability and value.
  2. Investing Basics

    Investing $100 a Month in Stocks for 20 Years

    Learn how a monthly investment of just $100 can help build a future nest egg using properly diversified stocks or stock mutual funds.
  3. Stock Analysis

    If You Had Invested in Walmart Right After Its IPO

    Discover the value of your shares in 2015 if you had purchased 100 shares of Wal-Mart Stores, Inc. at its initial public offering (IPO) price.
  4. Investing News

    Lessons From the Worst Investments Ever

    Investing in the stock market isn't foolproof. Things can (and will) go very wrong. Here's what some investors have learned from their worst mistakes.
  5. Investing Basics

    Why Blue Chip Stocks Are Key to Buy-and Hold Investing

    Several blue chip stocks have proven that buy-and-hold investing still works, even after the huge declines of the Great Recession.
  6. Investing Basics

    Are Financial Advisors Good Money Managers?

    There's a big difference between a good financial advisor and a good money manager. Here's how to tell.
  7. Investing

    What to Make of a Zero Percent Yield

    Interest rates hit a new bottom earlier this month when three-month Treasury bills (T-bills) were sold at a zero percent yield for the first time ever.
  8. Investing Basics

    10 Tips For the Successful Long-Term Investor

    Here are 10 investing principles that should help investors enjoy long-term success.
  9. Stock Analysis

    The 4 Best Buy-and-Hold Dividend Stocks

    Discover four of the best dividend stocks for investors to buy and hold, along with the reasons for each stocks' suitability for long-term success.
  10. Investing Basics

    5 Ways to Double Your Investment

    So if you want to go double, consider these five classic strategies to help turn your vision into a reality.
  1. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>
  2. What is the formula for calculating the capital asset pricing model (CAPM) in Excel?

    The capital asset pricing model (CAPM) measures the amount of an asset's expected return given the risk-free rate, the beta ... Read Full Answer >>
  3. What is the formula for calculating return on investment (ROI) in Excel?

    Return on investment (ROI) measures the performance of an investment by measuring the gain from an investment and the cost ... Read Full Answer >>
  4. Is it better to buy A-shares or a no-load mutual fund?

    Mutual funds and other pooled investments are popular among investors because they provide a level of diversity and professional ... Read Full Answer >>
  5. What is the smallest amount of shares I can buy?

    There is no minimum amount of shares that need to be bought in a single transaction, so an investor can purchase as little ... Read Full Answer >>
  6. Is Book Value Of Equity Per Share (BVPS) a good metric for long-term value investing?

    Book value of equity per share, or BVPS, also known as net asset value per share or simply equity per share, estimates the ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  2. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  3. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  4. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  5. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  6. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
Trading Center