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Thursday, February 25, 2010

Why investors board the wrong train and then refuse to get off

Why is it that many investors seem to specialise in boarding the wrong trains (read: stocks) and then simply refuse to get off, even though logic and common sense dictates otherwise?

After watching part of the presentation of the Railway budget, where the honourable minister thoroughly entertained the treasury benches as she took on the opposition by throwing taunts at them, I was reminded of a movie I had watched several years ago.

In the British film 'Clockwise', a very uptight and ridiculously punctual headmaster, played by John Cleese, is invited to speak at the headmaster's conference at a distant town.

He diligently prepares for the visit, goes to the railway station well on time, boards the train and starts memorising his typed speech - only to realise too late that he had boarded the wrong train.

He quickly gets off, but misses his own train and then faces one hilarious misfortune after another as he desperately tries to ensure that he is not late for the headmaster's conference. To cut a long story short, he eventually reaches the conference on time - in a dishevelled and chastened condition.

The moral of the story? Trying to be too punctual can create unnecessary situations, including boarding the wrong train. But getting off quickly may ensure that you reach your destination on time.

Many investors would rather follow the stock ideas of others than learn to do the hard work of stock selection themselves. That can create serious financial problems.

Either one buys into a momentum stock with questionable fundamentals. Or, even worse, one buys a fundamentally strong stock after it has already run up a lot and the smart money is getting out.

End result is the same. One is stuck with a stock bought at higher prices. Then begins a prolonged period of 'loss aversion' - asking questions at different investment groups about the future of the company and when one can get back one's 'buy price'.

Not selling a losing position in the hope of breaking even may be the biggest cause of losses faced by small investors. There is only one solution. Get off the train! If you learn how to set stop-losses, you will incur smaller losses.

(Haven't learned how to set stop-losses yet? Read Chapter 2 of my FREE eBook.)

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