Three mistakes novice equity investors often make

Most market participants are drawn to equity markets with the lure of exponentially multiplying their investments. However, making money in the stock markets is not easy. It requires a sound understanding of markets, in-depth research on companies, coupled with discipline and patience. Investment decisions are often fraught with behavioral biases which impact an individuals' ability to make sound and profitable investment decisions.

Companies create wealth and not markets, do not focus much on caprices of the market

The stock market is basically an arena for companies to profit from their strengths and get penalised for their weaknesses. As an investor, it is imperative that one is able to separate the company from the market. We invest in companies and not the markets. An investor friend of mine, Suresh, once invested in the shares of a company. His primary research led him to conclude that the company had robust cash flows and strong future growth prospects. However, shortly after having bought the stock, markets witnessed a sell-off and languished at lower levels for a few months. While Suresh remained patient and held on to his investment for a few weeks, he ultimately succumbed to market volatility and exited the stock at a loss. The company subsequently witnessed significant growth in cash flows and profitability, as a result of which the stock gave returns of more than 40% to its investors. Had Suresh concentrated only on the quality of the company and not reacted to market volatility, he would have made a good return on his investment. The best way to tackle such follies is to invest in companies that have the potential for superior business growth coupled with a strong management and at reasonable valuations. However, many individual investors lack the ability or resources to conduct in-depth research and make investment decisions. In such a scenario, investors can choose to invest in equity mutual funds which are managed by experienced professionals and are governed by the relevant regulator.

Trading and investing are different concepts – best results of investing are seen over a longer period of time

For any market participant, confusion between the concepts of trading and investment can be detrimental to his ability to make money in the stock markets. Trading is usually short term in nature and tends to exploit short-term asymmetries in the market. Investing, on the other hand, generally tends to be long term in nature as one needs to afford the companies sufficient time to profitably operate their businesses and that too on a sustainable basis. Short-term trading is highly sensitive to risk, as prices in the short term react to a variety of factors and are largely dominated by sentiment, rather than fundamentals. Investing instead requires a sound and disciplined approach that hinges on the fundamentals of a company. In order to increase the probability of generating good returns, it is better to turn to investments rather than trading, a lesson which my friend Neha learned the hard way. Neha followed the stock markets quite assiduously and was fascinated with the idea of making money on a daily basis. She approached the markets with a myopic view and rushed head on into trading. However, after making some money in the short term, frenzied activity in certain stocks wiped out all her gains and plunged her portfolio into losses. Market movements in the short term can have sharp impacts on our portfolio. It is always prudent to avoid reacting to such movements and to stay invested for a longer period of time, which allows such short-term ripples to smoothen out and have minimal impact on our portfolios. Again, individuals can choose to invest in long-term equity mutual funds, which allow investors to reap the benefits of long-term investing.

Avoid "herd mentality"

One of the basic tenets of stock market investing is to avoid flowing with the tide. A typical buyer's decision is often heavily influenced by the actions of the majority. However, needless to say, it is not necessary that the majority is always right. An acquaintance of mine often bought stocks that showed heavy volume and sudden spurt in activity. However, since his decision to buy was largely influenced by the actions of others, he was unable to justify his investments or implement a good exit strategy, which resulted in him netting huge losses. I would advise investors to always be wary of the herd and make investment decisions based on good research.

The writer is fund manager, equities BNP Paribas MF