Profit booking is the key to successful investing in stock market. Those investors who book profits regularly have a higher risk taking ability as they can afford to invest in stocks where others have not moved in yet. Over-owned stocks pose a higher risk of loss when the markets turn down.
There are some common mental mistakes we all make, that often lead to losses. Some of these avoidable errors are:
Over confidence
This can lead to complacency and over-exposure. It is the most common mistake investors make when they are making profits. In equity markets you can never throw caution to winds.
Herd Mentality
We often get swayed by what others are buying and then try to be a part of the crowd. We are tempted to believe that crowd is always right. If mid-caps are rising then we buy these stocks even when we know little about the companies. This leads to a paralysis when price suddenly falls and we are unable to take a call on the stock.
Excessive aversion to loss
Inability to book a loss when an investment goes wrong is the single biggest cause for losses to investors. More often than not, a small loss turns into a much bigger loss. Remember, a 40% loss started off as a 5% loss. Unless a stock has been bought on strong conviction of Long-term appreciation, those who make investments for quick gains must learn to exercise stop loss.
Fear of uncertainty
When we make money, there is instant euphoria. When we start to lose money, there is a sudden deer caught in the headlights type of emotion, which makes us unable to do the right thing. We fear that the moment we sell, will be the moment that it starts to rebound. This leads to inaction. If we book profits and the stock still moves higher, we feel bad. Therefore, if a stock is moving up most investors refuse to book gains. And many a times this ultimately leads to a loss.
Fear of making an incorrect decision and feeling stupid
This too leads to inaction. We often opt for inaction when faced with fear of making wrong choice. However, little do we realize that not acting in time too is a choice that we made unknowingly.
Reluctance to admit mistakes
This is another behavioural pattern that leads to incorrect decisions. In markets, we are loathe to admit that we made a wrong decision. However, admitting a mistake and taking corrective action often saves a lot of money.
Believing that investment success is due to their wisdom rather than a rising market, but failures are not their fault
This is another classical pattern. When the mid-caps are rising, we may believe that we were smart enough to identify the undiscovered jewels. However, believe it or not, if the sentiment turns no amount of ‘strong fundamentals’ is going to save their current valuations. The recent crash is a strong evidence of this fact where the mid-cap and the small-cap had a free fall.
Inaccurate assessment of investment horizon
Most investors make investments for short term but when the trade turns into a loss, they stick to it claiming that it was a long-term call. This could often lead to huge losses.
Forgetting the powerful tendency of regression to the mean
This is the most important lesson for investors. All stock prices must ultimately revert to their long-term averages. All sudden and sharp run-ups come to an end in a most unpleasant way for investors.
