Why do people lose money in stock market?

Ownership of good quality stocks has often been associated with wealth creation and financial independence. There have been several people who have made a good amount of wealth via stock markets – by investing, staying invested or trading. At the same time, there are many more who have  failed to emulate them, or lost money in stock markets.

While sometimes the times not being good is the reason (e.g. recession), there are many occasions where an individual has to take the blame. There can be many reasons for failure in stock markets like picking wrong stocks, being fooled by people, excessive greed, not having right temperament etc. Here are 5 common reasons why many people lose money in stock markets, even in not-so-bad times.

 

Why do many people lose money in stock market?

1. Excessive Greed

Godon Gekko (played by Michael Douglas in the movie “Wall Street”) said “Greed is good …” and some admirers have often hailed it as the cornerstone of their investing philosophy.  However, this may only be partly true. While it is good to aspire for good returns, we often tend to be too demanding (I want nothing less than 25% CAGR or something). This can lead us to take unreasonable bets (and be in deep red in say, small caps portfolio) or take unnecessary positions in futures & options (which you don’t understand & end up wiping out the capital) or fall prey to unscrupulous elements promising, say 10% monthly returns who run away with your money.

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2. Lack of skills

Stock picking require certain degree of understanding of nature of business, financials, how expensive/ inexpensive stock is etc. If you are a trader, you may need some understanding of technical charts. However, a lot of us don’t understand much of the above, you may be better off investing in mutual funds rather than direct equities.

3. Herd mentality

Everyone is buying stock X. OK. Let me also buy it. It has already risen 3 times in last year. / My neighbor has bought a new car with profits from F & O trading. Wow! Let me also do it and make some quick bucks.  

It is easy to get swayed by what everyone else is doing. But is that your only logic for emulating? Sometimes it may work. Often, it doesn’t. Apply your own mind and think for yourself what you ought to be doing.

4. Trading in futures & options

In a way this point can be covered under lack of skills and overconfidence, but given the magnitude of harm they can do, it probably merits another point!

People often jump to trading in future and options without having much understanding and end up losing money. (they can lose even if they understand them!). However, the lure of instant riches is so high that the risk of wiping out the capital is often ignored. Worse still, there are people who take loans at high interest rate (e.g. personal loans) to trade in futures & options and end up losing the capital, and left with an additional burden of clearing off the debt.

5. Temperament

One of the many virtues of a successful long term investor is sound temperament. They are usually able to be unfazed ( or at least, avoid panic) in bad times and not get too euphoric in good times. Panic selling stocks is often a sure shot way of losing money. This coupled with the fact that you bought it at highs (when everyone was euphoric and buying) adds to the agony. Markets rise and fall, and if one doesn’t have temperament to take this in stride, investing in equities may not be their cup of tea.

 

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Investing in stock markets have given very good returns in past, and will hopefully continue to do so in future, as the economy grows. At the same time, cherry picking stocks may not be everyone’s cup of tea. One needs to have the right understanding and temperament (along with some dose of luck!) to get good returns from stock markets. In case you don’t have them, you may take the mutual funds route wherein professionals invest on your behalf for a small fee.

 

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(PS – Not including “Recession” in the above list, as the objective is to highlight the ways people can lose money even if there is not recession or other macroeconomic factors beyond their control)

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