Tips to avoid losing money in the stock market

Investing in the stock market is more like a marathon than a sprint. It is not a get quick rich scheme so investors should not expect to earn money overnight. Success in the stock market comes from careful planning and education and the ability to stay emotion free when making decisions. See below some tips on how to avoid losing money in the stock market.

1. Select quality stocks by looking at the history – Only select stocks which have a strong earnings history. Avoid investing in companies which have yet to strategize a way to earn revenue. There have been many start-up companies which sound great on paper, they have yet to post a positive figure against net profit. A company which has had a strong earnings history does not mean the company will always do so but it potentially will be in a financially healthier position than a company that has yet to earn revenue.

2.Have a plan or strategy – Use technical analysis to select an entry point to buy the trade and exit the trade to sell the trade. Work out the resistance and support levels. This will help you keep your emotions out of the decision-making process as there is already a plan in place. Stay patient and wait for the stock to show signs of breaking higher before entering the trade. You can view more on technical analysis on the following link

3.Beware of the herd – Investors back in the 1990s were lured into investing in IT companies which had not yet worked out a strategy to be profitable. Investors were driven to invest in these companies as the stocks prices kept increasing. As they were afraid they would miss out on these opportunities, they invested into these companies. However, these companies collapsed as they were not financially stable. Similarly, if a good quality stock is being sold down, it can be beneficial to not follow the herd as you could be buying the stock at a value price. Technical analysis then adds another layer of sophistication in helping you get a better price. Again, investment decisions are best made where emotion is absent. Avoid pumped up stocks and do your own research before buying.

4.Rotate your stocks in accordance to where we are in the economic cycle – Some sectors will perform better than others depending on where we are in the economic cycle. We previously wrote up about rotating stocks in this blog, please see the link

5.Limit your losses by having stop losses in place – You can use a basic stop loss where you can specify the price you would like to sell your stock at. This tool will allow you to specify an amount you will be prepared to lose. Or you can use a trailing stop loss which tracks a pre-selected percentage level below the highest closing price. That way, the stop loss level increases as the stock increases. For example, consider a situation where CBA was $75 one day, $76 the next day, and continued to move higher towards $80. As the stock goes up so does the stop loss level. If you had a trailing stop loss of 10%, in this CBA example the stop loss will be $72 which is a 10% of the highest closing price of $80. If the stock decreases the next day, the stop loss will still be at 10% of the highest closing price.

6.Avoid Day Trading – Statistics do not support the success of day trading as 4 out of 5 people lose money (Business Insider Australia, 30 March 2010). One of the main reason is that day traders make emotional decisions. Day traders give up their full-time job to trade full time to try and generate enough income to replace their salary. However as there is so much pressure to make money they tend to make emotional decisions such as refusing to sell a losing trade and holding onto losses for too long. The high transaction costs involved in frequent buying and selling can also potentially erode the profits made.

7.Diversify your stocks in different sectors – If one sector is experiencing a selling frenzy then if you have diversified your portfolio then this loss might be offset by gains in other sectors. Over exposure in a stock is a bad idea as there is no such thing as a sure thing. However, remember you can over diversify with over 20 stocks. We have written about this topic previously on the following link:

8.Evaluate your portfolio regularly and adjust your holdings accordingly to your set exit points. Cut stocks that are not moving anywhere so you can free up the cash for other opportunities.

9. Only invest what you can afford –  Never invest money you cannot afford to lose. Investing is making your money work for you so you generate even more money, investing in the stock market is not a lottery. Do not invest all your emergency money in the stock market. This will increase the likelihood that you will be emotionally attached when making decisions as you are trading on funds that you cannot live with.  This put you in a precarious position and may cause you to make irrational decisions.

Lauren Hua is a private client adviser at Fairmont Equities.

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