The biggest mistake investors can make is buying a stock they don’t understand.
I’m willing to bet every single investor has made this error at some point in their career. That includes this author.
What a mistake to make
When I first started investing, I mistakenly thought I knew a lot about the oil and gas market. After all, I had spent hours and hours reading about the industry and studying successful companies as well as investments.
However, I had no actual experience within the industry. I couldn’t really tell if a prospective oil well was going to be successful. Also, I couldn’t tell if a company had the resources to develop a potentially lucrative oil resource.
Luckily, I realised I was making an error in judgement before I clocked up any severe losses, although I did end up losing money. Today, I’ve a far deeper understanding of the oil and gas sector, which I’ve been able to develop over the past decade-and-a-half.
Unfortunately, it’s all too easy to make this mistake. All too often, investors get caught up in the story rather than keeping a cool head. When investors get caught up in the story, rather than focusing on the fundamentals, it can be easy to overlook critical factors.
This is where mistakes happen. I made the mistake of focusing on the story all too often with oil and gas companies. I failed to acknowledge the challenges many firms encounter when trying to develop oil and gas wells.
Stick to what you know
I’m trying to avoid repeating these mistakes by sticking to the companies I know best. In many ways, this is easier said than done. I don’t think you really get to know a business until you have owned it for at least a year. Following the organisation closely during this time gives enough room to learn about the enterprise.
Following a company closely allows me to build up an idea of what makes it tick, how it earns money, and if I really understand the enterprise. If I don’t understand the business, I’m not going to try and force it. What’s more, I don’t want to rush the process, as this could lead to mistakes.
Of course, this is a time-consuming process and, on more than one occasion, I’ve missed a great opportunity. But that’s the risk I’m willing to take. I’d much rather miss an opportunity to make money than jump into a company I don’t understand and lose money.
This approach may not be suitable for all investors because it does require time and concentration. Nevertheless, I believe that by following this approach, I’ve been able to avoid repeating the mistakes I made early on in my career.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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