It’s one of the most common mistakes in the stock market. And it happens to almost everyone. Especially to those who are new to the market.
The mistake is..
Entering the market when it's near its highs.
That right there is the costliest mistake in the stock market. It will give you pain, make you suffer losses and it could cost you several years of valuable time of growing your investment.
Why does it happen? Why do most people get sucked into the market just before it falls?
The reason is simple. When the market is rising, people are making money. Everyone makes money in a rising market. This makes them believe they are skilled enough to consistently earn money from the market.
When they start believing this, they want to make even more money. They invest more.
They recommend the stock market to their family and friends. Even they enter the market.
This is when the market would be booming. The kind of market which we are witnessing now in 2020-21.
In such markets, some take loans to invest. Others sell their jewellery and land to buy more shares. Many are leveraged.
Extremely positive sentiments and high number of market participants. All feeling the need to buy more shares – without caring about current price or value. These are signs that the market is topping out in the short term.
Most people, especially those who have recently entered the market, ignore these signs. They haven’t seen it before. They haven’t experienced the pain of market crashes before.
They do not know the market can take away a year of big gains in just a few days or weeks.
If 2020 was outstanding for the market, those who entered after the crash in March last year.. will end up thinking the rally (rise) will continue forever.
But give this a thought:
- What if the market falls 10-20% from here?
- What if the stock you bought today crashes by 30-40%?
- What if the market moves sideways for 1 or 2 more years?
- Will you still be able to hold on to your stocks?
Let’s take a simple example to help us understand this better.
Let’s take one of the biggest car company in India. Maruti Suzuki India.
That’s the price chart of Maruti from 2016 to the end of March 2021.
The marked box on the chart is the area where most ‘new investors’ would be buying the stock, and most ‘smart investors’ would be selling.
There are several reasons why this happens:
- Towards the end of the rise of a stock, news related to it would be extremely positive. It would seem it’s the best company to invest in.
- The sales of Maruti cars would be growing every month.
- Analysts on business news channels would be projecting higher sales and giving higher price targets for the next few years.
- Recommendations to buy shares of Maruti would be highest on social media and WhatsApp / Telegram groups.
- You would hear analysts saying there is huge growth potential for the car sector in India.
An investor who is new to the market will read this and also see the share price of Maruti is rising every day. Thinking the share price will continue to rise in the future, he makes the decision to buy.
Even if the price doesn’t rise, the investor is confident not much can go wrong with a company like Maruti. After all, it’s the biggest car company in India.
Now look what has happened.
It has been a painful 3-4 years.
Maruti crashed after a strong rise in 2017-2018. And even after a strong bull market which has seen Nifty touching all-time highs, Maruti is still more than 30% below its all-time high price.
About 6 months after the stock touched its high, the car-sale numbers started dropping. But by the time the growth stopped, the share price had already fallen 30-35%.
This is exactly what happens in the market to several stocks. New investors buy when the news around a company is super positive – all the positives are already factored-in to the price. The fundamentals seem too perfect to be true.
Then the fall comes.
This catches the inexperienced investor by surprise. How can the share price of a company that’s doing so well, suddenly start falling?
They ignore the initial falling, thinking it is temporary. The price would bounce back again, they tell themselves.
In reality, the smarter investors, who had bought the shares at much lower prices, are the ones who are actually selling the shares. This period is called ‘distribution’.
The share price falls further. Suddenly there’s disbelief. The fundamentals are still intact. Why has the stock fallen 20%?
The fall continues. The loss is 30% now, too big a loss to sell. This is when most people who come with a mindset of making some quick money – truly become ‘long term investors’. It’s not because they want to stay invested for long, but the market has forced them to wait.
After the price has come down significantly, the fundamentals begin to reveal the hidden story.
CNBC declares: Maruti car sales crash 24% in September
That was in September 2019, a year after the share price had started declining.
This is when fear is at its peak. A new investor has already lost 30-35% of his investment. Imagine how an investor who has taken a loan to invest in Maruti, would be feeling at this point. He has to pay back his loans, pay interest on it.. but the share price is falling everyday.
This is when the market forces him to make another mistake.
Mistake 2: Sell when the news is extremely negative.
When the news is negative and there is fear all around, the share prices are usually at its lowest. It’s not a time to sell, but a time to buy.
But most new investors end up selling at this time – out of fear. And guess who is buying from them? The smarter investor, of course. Those who have already seen the market cycles. Those who can now see value in the price.
The share price begins to rise. Usually, almost immediately after new investors sells out of extreme fear.
When the price rises, the sentiment improves. And the market cycle continues.
This is when some investors, who stayed invested during the fall, can make yet another common mistake.
Mistake 3: Sell when the price returns to the buy price.
An investor who bought Maruti at 7000 in 2017, struggled through its ups and downs for 3 years. Saw the price crash to 4000 in March 2020 – would be waiting for the price to return back to 7000.
He does not understand that inflation has already eaten into his investment over the past 3 years. He also does not understand he would have fetched 5-6% from fixed deposit.
He does not want to incur a loss in Maruti. He wants to sell the shares he bought for 7000.
Sold.
This is when almost all the ‘weak hands’ are out of the stock and the price – in most cases – continues to rise higher and higher.
These are market cycles. The market always manages to catch its participants by surprise.
Expect the unexpected here.
Mistakes will be made. Even the biggest and most successful investors have made mistakes. They will continue to make mistake, but with experience the mistakes will reduce considerably.
That’s good enough.
The beauty about the market is – a few right decisions can make up for several mistakes.
Until you get there, keep learning.
I hope this article will help you reduce some of those initial mistakes and help you make a more informed decision.
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