Question No. 9

"I've Heard That Most
Amateur Investors Lose Money,
How Can I Avoid Being One of Them?"

Our Response

Perhaps it would be more accurate here to state that most "newbie" investors lose money in the Stock Market.

And that would be very true.

We find it incredible that amateur investors buy when shares are high and sell when shares are low.

The exact opposite of what they should do.

Don't believe this?  Read on.

"Why Most Newbie Investors
Buy Near the Top"

'There is a very simple explanation to why most newbies lose money when they first try to trade.

It's to do with investor psychology.

It goes something like this:

Amateurs are reluctant to get involved in the early stages of a Stock Market rise.  It's when they see that the markets are rising and everybody is piling in that they think they're missing out.

But they still procrastinate.  Eventually, they give in and finally join the party.  And at first, their shares probably rise.  What they don't realise is that they have probably just bought at, or near, the top of the market.

The professionals are baling out.  But the mug punters are still piling in which is what is holding the market up.

This process can go on for some time.  It's called the 'Distribution' phase. What is happening is that there is a transfer of share ownership from the strong holders (the professionals) to the weak holders (newbies and amateurs).

Sooner or later (and probably sooner), there is no professional money left in the market and any buying that is going on is trivial.

It is probably at this point that the market makers, or specialists as they are called in the US, mark the shares up quite sharply.  This has the effect of dragging in more and more mug punters (thinking that the market is going to the moon). But on very small volume of shares traded.

The market makers are "testing" the market to see if there are any real buyers left.  And of course there are not, hence the low volume.

They have effectively tricked the "weak" buyers into thinking that the market is going to go higher still.

What then happens is that the market makers then mark the shares sharply lower. 

There's not enough buying to keep the market going up.  Not even enough to keep it where it is.

Consequently, the Market Makers start marking down the shares in a bid to attract buyers.

But the professional buying has disappeared.   The consequence of which means falling prices.

Consider now the emotions of the newbie investor that got in late.  All because he wanted to join the party.

At first, he may have felt quite smug because his shares rose soon after he bought them.  But when the Market Makers started marking his shares down, he didn't feel smug any more.  In fact, he started to worry.

He's never 'played' the Stock Market before but now he was showing a small loss.  And he's thinking: "should I sell or hang on in the hope that I can get my money back?"

No prizes for guessing what his decision may be.

He's really undecided.  Just a few more pence and he may get out even.  A bit more than that and he can get out at a small profit.

So he hangs on.

And the shares are marked lower still.

Oh dear!  Now he's showing a real loss.

He decides he'll keep them.  Ever hopeful of a recovery.

Now he's really fearful.  "What if the market crashes?"  He thinks.  Meanwhile, the shares are still going down.

What is happening here is that the Market Makers can't attract any buyers at all so they mark the shares down to try and attract them. The harder it is to find buyers, the more the shares fall.

Until the shares find a level where there is no more floating stock left and the market starts to drift sideways.

This is where the professionals start to buy the shares back.

"Why Most Newbie Investors
Sell Near The Bottom"

As supply becomes available the professional money soaks them up.  This is called the 'Accumulation' phase. Which is essentially a transfer of share ownership from the weak holders (newbies) to strong holders (the professionals).

What is happening here is that the market is getting ready for the next big up-move.  Although to the amateur investor it certainly doesn't feel like it.

And when the market is finally ready to move up, the Market Makers do the exact opposite of what they did at the top of the market.

They mark the shares sharply lower in an attempt to "test" the market.  Are there any big sellers left?  Low volume tells them that there aren't.

And it is at this stage that our newbie investor can't stand it any more.  He thinks the market is going to crash, he's had enough and jumps ship.

He'll sell at this point.  But the Market Makers can see that because of the low volume for this "test" they know that there are no more big sellers left.

This is the signal for the Market Makers to start marking the shares up again.

Market Makers have a unique position.  They can see BOTH sides of the market.  The buyers, and the sellers. They are the best brains in the business and us mere private investors cannot possibly go head to head with them. And we shouldn't try.

Our unfortunate newbie went on an emotional roller coaster.  First one of optimism, then fear, then panic.  It's a common theme.

What he's just done is classic for many small investors.

"Understand How
The Stock Market Really Works"

There seems to be this reluctance to understand how the Stock Market really works.

Be one of a minority of private investors who take the trouble to learn a few of the basics.  This website will help tremendously here.

So why do the majority of small investors lose?

Our theory is that they would prefer to work to a set of rules rather than think for themselves.  Yes, you need rules.  But they must be your own.  And you must stick to them

Trading the markets is largely about emotion.

People fear missing out on something (FOMO) Hence the getting in near the top.

People fear losing money.

People fear being wrong.

People get greedy.

People get over-confident.

And because of this, people commit the biggest sin of all - they over-trade.

Always looking for that ten-bagger.  They'll be lucky!

As a DIY Pension Investor, you need patience and discipline.  You simply cannot, and most definitely should not, trade irresponsibly.

Below are a few common problems that amateur investors consistently make.  Don't be one of them.

"A Few Common Mistakes
Newbie Investors Make"

Newbie investors are impatient.  They want instant success.  Rarely would that happen, and if it did, it would be pure luck.

Below are just a few common mistakes made by amateur investors.

1. They are un-realistic

Most amateurs are looking for that elusive "ten bagger."  It rarely exists. 

Real wealth is made when you invest for the long term.  Remember - it's a marathon not a sprint.

2.  Tips 

Don't take 'em.  Don't give 'em.

Do your own research (as shown on this website).

Don't read tips in newspapers or magazines.  You are your best investment advisor.

3.  Education 

Face facts.  It's crazy to enter the Stock Market with real money if you haven't learned at least the first principles of investing.

Study the legends.  Read the books by these masters.

Make your own set of rules.  And stick to them.

4.  Only Trade Bull Markets 

Stock Markets don't go up forever.  What goes up, must come down.

You do not want to be invested in shares when the market turns down.  Sure, you'll never get out of the market at the exact top.  Nobody can do that.  Likewise, you'll never get back in at the exact bottom.

Try to identify when a Bull Market comes to an end and get out, and buy a short ETF.

It's then time to be patient and wait for the opportune moment to buy again. 

"One Final Illustration"

Here's a brilliant piece of factual information that illustrates extremely well the principle of buying and holding, until you get a signal to do otherwise.

If you had invested £10,000 in 1990 then by 2005 that would have grown to over £50,000.

Nice one.  A five fold increase over 15 years.  And that takes in the dot.com problem at the turn of the millennium.

To illustrate the folly of not holding for the long term, suppose:

you had been out of the market for the best 10 days of that period. Would it shock you to realise that your portfolio would only have only grown to £32,000?  Quite a difference when compared to £50,000+

Now suppose:

You had been out of the market for the 30 best days of that period (which is approximately one month). Your little nest egg would indeed be just that - little. Barely over £15,000.

And suppose:

You had been out of the market for the 50 best days in that 15 year period.  You would have actually LOST money.  Your total investment would only have been worth around £9,000.  Ouch!

Need any more convincing to invest for the long term?

Conclusion

Don't be an in-and-out kind of investor.  Don't over-trade.

Be 'in' for Bull Markets, and 'out' for Bear Markets.

When you're in - stay in.  It's next to impossible to predict which days are going to be the best ones, so it more than makes sense to stay in and ride out the bumps.

Take the time (it doesn't take long) to understand how the Stock Market really works.  Do that, and you'll never fall foul of getting in at the wrong time or out at the wrong time.

Footnote

As a newbie, you may want to read the other "Frequently Asked Questions" on this website.  Doing so, will give you a good introduction to running your own DIY Pension.

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