The stock market can be a dangerous place for those who have no idea what they are doing.
Mind you, it can be dangerous even for those who think they know what they are doing, and even the professionals at times.
It's important that investors considering putting some funds to work in the stock market get at least a little education about the share market, how it works, what types of shares are listed and some of the various strategies of investing.
1.
The easiest way to lose a bundle is to invest in companies that you know nothing or very little about. As we wrote a few weeks ago, companies operating in the aged care sector are highly complex beasts – in how they earn their revenues and how they classify some accounting items that can trip up beginner investors. Even the professional analysts appear to have misunderstood Estia Health Ltd (ASX: EHE), Regis Healthcare Ltd (ASX: REG) and Japara Healthcare Ltd (ASX: JHC) and are overlooking the very real risks to their businesses.
2.
Another sure fire way of losing all your capital is to invest in speculative companies, whether they are tiny lithium or graphite explorers, highly promising biotech or unprofitable pharmaceutical companies. Many of these companies are likely to fail before they can become a commercial success, and if the share price has already run up strongly, most of the early gains have likely already gone.
What investors may not realise is that many speculators may have already bought in and they are just waiting for newbie investors to come along and buy the shares off them at too-high prices. There are an estimated 30+ tiny companies on the ASX that are attempting to capitalise on the huge expected demand for lithium. Maybe 4 or 5 will be successful – if they are lucky.
3.
Chasing the next hot stock and over-trading. If a beginner investor jumps into the market and tries to jump from one hot company to the next, transaction costs are likely to eat away at your capital and could see investors lose most of their capital. Fancy competing against super-fast computers that can execute trades within a trillionth of a second and pay a fraction of the brokerage retail investors are charged per trade? Go ahead and set fire to your cash – you will probably lose it slower.
There are a number of ways that beginner investors can avoid these traps. Firstly, invest in companies that you know well, companies like Woolworths Limited (ASX: WOW), Wesfarmers Ltd (ASX: WES) or Telstra Corporation Ltd (ASX: TLS). At the very least, you are unlikely to lose all your capital that way, even if their shares are expensive.
Or even better, start with highly diversified stocks – listed investment companies (LICs) or exchange traded funds (ETFs). And dip your toe slowly into the market. That may mean buying smaller amounts, rather than jumping right in with all your cash.
Foolish takeaway
Treat the stock market like a casino and you'll get similar results to a casino. Over time, casinos are designed to win and the vast majority of punters walk away with a losing hand.
However, treat the stock market as a means to invest sensibly and your future self will thank you.
