The Motley Fool

3 Traps to Avoid in the Stock Market

Everyone even Warren Buffett makes investing mistakes! Many times what we perceive as an error or failure is actually a gift. And eventually, we find that lessons learned from that discouraging experience prove to be of great worth.

Many years of observation have taught us that one of the main reasons why investors lose money is because they have bought low-quality shares. Here are three traps investors should avoid in the stock market:

1. Avoid Celebrity Stocks Without Concrete Business Models

A Case Study on SEHK:0276

One of the four largest property companies in Hong Kong, New World Development (SEHK:17), bought Paul Y Properties (SEHK:0276) and renamed it New World Cyberbase to take part in the mania. From a low of $8.48 in 1999, the shares rose to a split-adjusted price of $249 in Jan 2000. But by Dec. 2005, after the tech bubble burst, the shares had dropped to $0.52.

The story was repeated in 2007, when New World Cyberbase renamed itself Mongolia Energy to hitch a ride on the commodity gravy train. It soared to a high of $72.24 in June 2008. But it was crushed again during the Global Financial Crisis. As of March 2019, it’s trading at just $0.16.

Throughout the mania and the commodity fever, the company didn’t show any decent revenue growth, not to mention earnings.

This example demonstrates how much wealth can be destroyed during market boom-and-bust cycles. But we are unlikely to avoid this through well-timed, hit-and-run trading! It simply goes against human nature. I’ve discussed the common behavioural bias – loss aversion — in the Special Free Report.

2. Avoid Buying Micro Caps on Tips and Rumors

People who provide tips and spread rumours about micro-cap stocks with virtually no business value or assets have only one motive: Sell their shares to you at a higher price than they had paid for it. By the time you hear about the rumours, odds are that the stock’s about to crash. This kind of investing is no different from gambling.

3. An Insider’s Perspective on Technical Analysis & Algorithmic Trading

Technical Analysis

I was a technical analysis fanatic in my early career. I thought I had found the Holy Grail of investing by back-testing a stock’s past price history. The mechanical rule that I had discovered helped me make money in the first year. However, I failed in the subsequent two years and lost twice as much as all my past gains.

Technical analysis is basically statistical tables, plotted in graphical form to assist an investor’s decision-making process. However, it only works in some conditions, and only some of the time. Technical analysis is imaginary. In other words, it is useless!

Algorithmic Trading

My friend Eric, who was a quantitative finance graduate from the Ivy League, worked in a reputable investment bank as an algorithmic trader for several years. He was successful in the first couple of years, but intense competition drove him out of the market by the time he was 30 years old. The working environment was stressful; you need focus to continuously monitor the market, and the heavy workload left Eric burnt out.

Eric told me he won’t encourage his son to enter this industry, since careers like his tend to be short-lived. On the other hand, the Oracle of Omaha, master investor, Warren Buffett, is still active at 87 years of age by applying slow and steady fundamental analysis. If algorithmic trading is not a game for a young, talented quant guy, then it is not for the general investors, either.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Hayes Chan, CFA doesn’t own shares in any companies mentioned.