This article originally appeared on Quora: What’s the biggest mistake that stock market investors make?
No single mistake leads to poor returns. A consistent pattern of mistakes does.
And a consistent pattern of mistakes indicates larger problems. Poor returns and losing money are just symptoms.
Having said that, I believe poor performance can usually be attributed to these four big root problems:
- Lack of hard work: without hard work, your only hope is to get lucky
- Lack of process: until you have a process, you don’t know what you are doing
- Unrealistic expectations: without realistic expectations, you are set up to over-reach
- Complacency: being complacent leads to getting punched in the face
On a daily basis, these problems transpire as tangible symptoms that mathematically eat away at returns.
1) Lack of Hard Work
Lack of hard work is very costly, because it leads to missed opportunities.
For example, there are tens of thousands of full time traders that are watching earnings & economic indicators every day. If you are a part-time trader, you won’t be able to react to these events before any of these guys.
Just think about the last time you went to Whole Foods and tried to buy fruits.
The best fruits without defect are always sold first. Only the weird shaped / damaged ones are left at the end. It’s the same with stocks. You will miss out on the best trades if you snooze.
Lack of commitment hurts whether you are stock trader or a VC or a real-estate investor.
The good deals / the good trades / the good land does not wait for you to find it.
If you want to make money, you gotta hustle. Be a voracious reader. Warren Buffet is said to have read financial statements of all public companies.
Lack of time commitment is a big problem for many. I have friends who live in the West Coast who complain about poor returns.
I ask them, how long do you look at the market?
They say less than 30 minutes a day.
I ask them to let me know when they get rich working 30 minutes a day.
2) Lack of Process
Most humans are wired to perform better and more consistently when following a process.
When it comes to investing, however, most investors do not have a process/system.
Without an investing system, most people let their emotions take over, which leads to poor decision making.
Not having a process is very dangerous, because ultimately it leads to lack of faith.
This lack of faith tangibly leads to poor returns in the form of over-trading, and lack of risk-control.
It is easy to see how the lack of faith leads to over-trading.
Because you have no “north star”, you flip-flop. The more you flip-flop, the more you trade, and the more commissions you pay.
Lack of faith also leads to lack of risk control. When an investment is in the red, you will be second-guessing every decision even if your gut tells you to cut your losses.
A good process typically involves:
- R&D: Creating strategies, systems, acquiring data
- Screening: Using your systems to filter the universe down to a smaller set of actions
- Pre-trade analysis: Using another system to analyze a small set of actions in-depth
- Monitoring: Using another system to watch your current positions & the market
- Post-trade analysis / Post-Mortem: Figuring out what went wrong or well and learning from them
If you don’t have a consistent process, it is impossible to achieve consistency and learning.
Your revenue will be unpredictable.
3) Mis-alignment of Risk Profile to Returns Expectations
Over-allocation / under-allocation of risk is a symptom of this mis-alignment.
I always wondered why so many smart people got into trading penny stocks or binary options.
It’s simple. They are optimistically greedy. Too much so.
Unfortunately, the same people are totally unprepared when they get hit with -50% losses.
To prevent this, investors need to:
- understand what they can afford to lose
- figure out what type of return they want to shoot for
Without having a good alignment of your portfolio and your risk profile, you are bound to panic / over-lever.
Assays, it is important to understand the return characteristics of every investment you make.
If you want to never, ever lose more than 5% on a given year, then it’s hard for me to recommend a large stock allocation to you.
4) Complacency / Unwillingness to Adapt
Complacency is the biggest enemy of sustained success.
And complacency is also hard to avoid.
Complacency transpires into unprofitable mistakes such as: lack of profit taking, over-riding systems, ignoring the canaries in the coal mine, etc.
Humans are wired to project the past into the future.
Unfortunately, most good things don’t last forever without constant monitoring and sticking to the first principles.