Why People Lose Money In The Stock Markets?
Have you ever wondered why some people are so successful in the stock markets while most of the others are not? Earning profit from the markets is no child’s play and it requires the use of a carefully developed strategy to be profitable. Unfortunately, most of the investors ignore this fact. They get lured by the returns that the markets have generated in the past, and trade recklessly without any strategy.
At the end of it, they end up making losses which cause a lot of heartburn and distress.
So what are the main reasons why people lose money in the market? Let us understand some of the common mistakes that they make.
- Over-leveraging:Over leveraging refers to taking huge trading positions in the market with a small sum of money. For example say you have Rs. 100 in hand and get into a trade of Rs. 10000 with it. Effectively you have taken a leverage (loan) of Rs. 9900.
Such over leveraging increases the risk in trading. If the market moves in the direction of your trade then you will make money very fast. Otherwise, if the markets go against your expectations, you will lose money at the same pace
Suppose the market makes a movement of 1% in the wrong direction, then you will end up making a loss of Rs. 100, which is 100% of your capital. Thus you will lose all your capital and will be left with nothing.
Taking such a huge position is reckless move and his extremely risky. Unfortunately, we have seen hundreds of investors lose their entire trading capital by making this mistake.
- Fear ofbooking losses: Many traders are extremely quick in booking profits but do not want to accept losses easily. Whenever small profits come they jump in and square off the trades. However, when the markets move adversely, they will keep waiting with the hope that their loss-making positions will eventually turn profitable someday. Thus, they will let their losses run and become big.
Let us understand this with an example. Suppose, a trader invests Rs. 100 in the markets. When the stock prices start moving up, he will quickly book his profits as soon as the position goes up to Rs. 102 or 104. However, when the markets go down, he will keep waiting. When the prices go down to 95 he will hope that the markets will rise soon. When it goes down to 90 he will even think of averaging the position to bring the cost price down. If the price goes down further he will panic and book the losses.
Putting a stop loss is a great way to avoid this. Decide on how much risk you can take and cut the losses without emotions when the price falls below that threshold.
- Trading without a plan:Most investors trade in the market without a systematic approach or plan. They will try to grab every opportunity that they can get in the markets and have knee-jerk reactions when it comes to exiting the positions.
For example, a trader Mr Jain enters a stock at Rs. 100 thinking that the company has good long-term prospects. Now when the price goes up to Rs. 110 he suddenly becomes very happy and sells the stock to book the profit of Rs. 10. So effectively he exits a stock which has good long-term prospect and can definitely go up to rs. 150, just to book a meagre profit of Rs. 10.
On the other hand, Mr Patel enters into a trading position thinking that a stock that is trading at Rs. 200 can go up to Rs. 205 within the same day. Unfortunately, if the price goes down, Mr Patel will be shy about booking profits and think of taking delivery of the stock, hoping that it will go up in the near future.
Most of the investors get confused between intraday trading positions and delivery based positions because they do not have a definite strategy for trading or investing in stocks. This is very dangerous and can cause huge losses.
- No data research:Making profits in the stock markets requires hard work in the form of research which the trader or investor has to do. They need to analyse data to understand which stocks have solid fundamentals and which of the ones which are going to do well in the future.
Most of the market participants ignore this essential requirement. They either watch business channels, call of their broker for investment/trading recommendations or look around for tips from people they know. Eventually, they trade without understanding whether the stock is actually good or not and end up making losses.
- Transaction costs:There are various costs like brokerage, exchange fees, SEBI fees etc. which everyone who trades in the markets has to pay. This brings down your profits.
Understanding how much transaction costs you will have to pay will enable you to understand the minimum profit that you need to earn in order to cover these costs and actually earn some profits. Most of the investors and traders do not do this calculation and jump at every small profit that they see. Many a time such small profits or not enough to cover the transaction costs and they end up incurring net losses from the trades.
- Technology:The modern trading systems have evolved quite a bit and most of the trading nowadays is happening on an automated basis. So if you are still doing manual trading or is depending on your broker to place your orders, then you will be at a disadvantage, since you are now reading against sophisticated software-based trading using algorithms.
The traders who are consistently making profits these days are the ones who are disciplined. The algorithms have no emotions and are the most disciplined trading entities in the market today. If you want to compete with them then you will have to build the same level of discipline in your trading style. Use a system based trading so that you are able to compete with the algorithms effectively.
This article is for education purpose only. Kindly consult with your financial advisor before doing any kind of investment.