When I bought my first stock, I created a spreadsheet. It had optimistic and pessimistic scenarios. The worst case scenario was the stock goes down 50%. I don’t remember the best case scenario.
When I keyed in that scenario, I chuckled to myself and thought that it would never happen. It happened in about two weeks.
That was my first investing lesson:
Stocks can go down to zero.
But not all my stocks went down to zero, there were a few which didn’t go anywhere at all. One was stagnant for a full year before it started its upwards journey. I lost patience during that time and sold it off just before the big rally. A stock can jump tremendously in a few trading sessions and investing requires patience. Just because a stock hasn’t moved anywhere in the last year — doesn’t mean that you can’t make a killing on it. That was when I learned:
Growth in stocks is not linear.
When the market peaked last time around, I invested in one particular stock that was trading at its 52 week low and at a reasonable P/E. I expected the markets to go down, but I thought this stock would probably not go down much (as it was already low).
When the bubble burst — this stock nose – dived faster than anything else I owned. The lesson:
Just because it’s low, doesn’t mean it won’t go lower.
During the peak, I was tempted to book partial profits in a lot of my stocks, but I resisted because I generally don’t sell the stocks I own. Instead, to hedge, I bought a lot of PUT options. The trouble was that Options are priced based on price and time to expiry. So sometimes even if the price of the underlying goes down, if there isn’t much time left for the Option to expire — the price of the Option won’t rise by much.
Buying PUT Options is not a simple hedge against market downturns.
When the market eventually did tank, I was really tempted to buy the stocks that have fallen most — to dollar cost average. But, I learned in the dot com crash that dollar cost averaging is just silly.
The reason for that is opportunity cost. When you buy a stock that has fallen, just because it has fallen, you are giving up the opportunity to buy something better, which you don’t already own. If I bought AIG at $30 and the stock drops to 40 cents — there is a great opportunity for me to dollar cost average, but really — is that the best place for my money?
Buying a stock to lower your average cost price is just fooling yourself.
I am sure that I have not made every investing mistake that I could possibly make, but I do know that I won’t be making any of these mistakes again.