Losing Money in the Stock Market? There are some ways to avoid it. This article is mainly related to the tips for the investors about the proper and profitable investment in the stock market.
Why Do You Losing Money in the Stock Market?
The crashes in the stock market have impacted the American financial system directly from the last 100 years. The great depression decreased the stock prices. In 1987 crash, each day the overall market for stock and shares fell by the percentage of 20.
“Buying on margin is one of the many modes that can cause loss of huge amounts of money due to stock market crash.”
Selling After a Crash
Lack of understanding towards the effect of the fluctuation in share prices causes to decreases the wealth of the investors. Most simply, the investors buy shares at a certain price, and then they can sell these to realize capital gains. On the other hand, if the share prices go down, the investor will not realize any gain.
To understand the term of the price drop, let us consider the following example. Suppose if an investor buys 1,000 shares in a company for a total of $1,000. Now, if the price of shares drops by 75%. Consequently, the investors’ position will fall from 1,000 shares of worth $1,000 to 1,000 shares of worth only $250. If the investor sells his shares at that time, he will face a loss of $750. If an investor didn’t panic in this situation and kept his money in the investment, there could be the chance that he or she will make backs the loss when the market rebound.
Buying on Margin
Buying on margin is one of the many modes that can cause loss of huge amounts of money due to stock market crash. The buying on margin is the strategy for investors in which they can make a profit by borrowing money. Particularly, in this strategy, the investors get loans from the bank on interest to purchase some securities.
In this strategy, the buyer invests his saving also with the borrowed money. After some time, when the investor sells the position, he repays the loan to the bank with interest and keeps remaining small profit. For instance, an investor wants to purchase securities of 1000. He will add his saving of $1 with the borrowed amount of $999, from a bank on 5% interest. The yield of 6% on ROI will be 11 that is the profit of the owner. The yield generated from the investment goes to the investor, and he pays back the only amount of loan and interest to the bank.
The buying on margin strategy is good for the investor when the market rates are increasing, while in market crashes investors face loss. For a similar example if the investment drops to $100 the investor will face the loss of 1000. He will face not only the loss of $1 but also $950 that he has to pay back to the investor. Thus the buying on margin generates the loss for investors.
The investors take positions on margin to earn more return on investment. Therefore they take large amounts from the banks to purchase such securities. When the market prices go down, or financial crisis occurs it turns into the large opportunity for loss. Investor not only loss there personal assets but also cause for bankruptcy. Therefore security exchange commission is setting new rules to overcome this issue.
“The mistake they do is that they keep on holding to their losers, with a hope that someday these will generate a huge profit.”
Ways to Avoid Losing Money in the Stock Market
Sometimes we meet the people who asked that how they can avoid loss in the stock market. What should the investors do to earn a profit margin?
The question is valid. People usually keep portfolios with more than 50 companies stock recommended by their friends or family. They even invest in the companies that have poor fundamentals and weak business. My working experience with Russin for the portfolio management, that was down around $40000, supported me to learn portfolio management. We were used to reviewing stock, whether it was inside or outside, and to decide about which we should keep, and which we should sell. It also included the buying of some new shares according to our thinking. Fortunately, we did well in this and somehow the portfolio, which was down around $40,000, generated a profit of $2.3 million just three years after we stepped in.
Through this experience in investment, we find out that there are some major techniques and rules for performing well in the investment business. There are five things mentioned that investors should do to overcome the continuous loss in the stock market. If some investor’s portfolio is at too much loss, then he can turn the things around by considering these things.
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Compound Your Winners, Not Your Losers
It is seen that the investors with a losing portfolio around, usually make one major mistake in their business. The mistake they do is that they keep on holding to their losers, with a hope that someday these will generate a huge profit. The losers are the companies that have poor fundamentals and weak business.
The simple logic of this business is that “investing is game, strongly based on probability”. We can’t forecast the future of a company, but it can be predicted that a company with strong fundamentals is more capable of generating profit as compared to a company with weak business fundamentals. So if an investor wants to gain profit, he or she should clear the losers first. This will not just only decrease the amount of loss but will also provide a sufficient amount of cash to focus on other companies with better opportunities.
If an investor wants to clear losers, at the first the investor should classify the companies in four categories, based on earnings and model of business.
- Recurring earnings
- Non-recurring earnings
- Weak business model
- Strong business model
The investor should prefer the companies having a strong business model on weak business model companies. The other thing is to get rid of the companies with weak business models. They should select companies with recurring earning and strong business models. Thus they can increase the chances of a high return on investment.
Always Invest in Good Companies
The second step to avoid losing money in the stock market by selecting good companies to invest. An investor should avoid repeating the same mistake by investing in the loser companies again. Instead of wasting your money by investing in losers, again and again, invest in the good companies that have a dominant market position and have the potential to earn recurring profits. Companies with dominant market positions generate strong cash flows and pay to the large shareholder amount of dividend.
Despite all of the possibilities of higher profit, purchasing the stock of the good companies is not an easy task. It is because they sell out their stock on the high prices. Thus paying too much to have such stock is only not a good idea. Therefore the investor should value the company properly and avoid paying extra money on high prices shares.
“The Diversification of portfolio plays an important role as it helps the investor to minimize the effect of non-market.”
Diversify But Don’t Over-Diversity
The Diversification of portfolio plays an important role as it helps the investor to minimize the effect of non-market. The investor cannot control the market risk they have only control on the non-market risk. There are the factors as recessions, natural disasters, and interest rate fluctuation that increases or decreases the market risk. Investors sometimes over diversify the portfolio and increase the number of companies that also increase the risk factor. New investors cannot review in detail the portfolio if the companies are more than 50. Therefore, they take the wrong decision.
A book named “Modern Portfolio Theory and Investment Analysis” is written by the authors Edwin J. Elton and Martin J. Gruber discussed the reduction of the non-market risk. The book claims that non-market risk can be reduced to 80% by investing only in 20 companies. The best diversification is to invest in just 10 to 20 successful and good companies.
Give Your Tree Time to Grow
Investing in a company is similar to growing a tree. Although it could be just a small plant now, as long as it is deeply rooted, it will persist to climb. All you have to do is to monitor its progress after every few months. It is for to ensure that the roots, stem, and branches stay strong. Now, after the growth, he can enjoy the shade and fruits of the tree. It is impossible that you plant a tree and then you start expecting that it will grow into a huge tree at once. The same is the case with investing in the stock market.
The investor should not expect a sudden shoot up in the market value of the stock. Rather than this, the investor should wait to let the market prices increase with the time. Investors should focus on the long-term results. They should consider the economic conditions and yearly growth of the companies.
Opportunity Is Key
Investors sometimes deploy their money quickly when they get the sizeable cash board because of the fear of loss. However to attain success in the investment the investor should focus on the opportunity as the opportunity is key to success. The investors should take the advantage from the opportunity. When the prices go down because of temporary crises they should purchase the stock. Attempt to own stock on discount prices and wait for the maximization of the return on investment. Understand the market and seek opportunities to maximize the profit.
Finally, for long-term success, the stock investor should consider the previous success of stock but purchasing stock by past performance is not a brilliant method the main consideration should be for the fundamentals of stocks. The healthier position in the company is based on the financial stability of the investor and the earning process for the revenues. The emotions have a significant impact on the stocks and change the fundamentals of the investment decisions. The swayed and unfavorable events induce a negative impact on the positions in the market. The boosting of the economy, in our vision, is based on the proper investment.
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