Dangerous Moves for First-Time Investors (2024)

There are some common mistakes that first-time investors have to be aware of before they try their hand at picking stocks like renowned investors likeWarren Buffettor shorting likeGeorge Soros.

Jumping in Head First

The basics of investing are quite simple in theory—buy low and sell high. In practice, however, you have to know what "low" and "high" really mean.

What is "high" to the seller is considered "low" (enough) to the buyer in any transaction, so you can see how different conclusions can be drawn from the same information. Because of the relative nature of the market, it is important to know before jumping in.

The basic metrics such asbook value,dividend yield,price-earnings ratio (P/E) are fundamental items to learn. Understanding how they are calculated, where their major weaknesses lie, and where these metrics have generally been for a stock and its industry over time can help a new investor immensely.

While you are learning, it’s always good to start out by using virtual money in a stock simulator. Most likely, you'll find that the market is much more complex than a few ratios can express, but learning those and testing them on a demo account can help lead you to the next level of study.

Playing Penny Stocks and Fads

At first glance,penny stocksseem like a great idea. With as little as $100, you can get a lot more shares in a penny stock than ablue-chipthat might cost $50 a share. And you have a lot more upside if a penny stock goes up by a dollar.

Unfortunately, what penny stocks offer inposition sizeand potential profitability has to measure against thevolatilitythat they face. Penny stocks arepenny stocks for a reason—they are poor quality companies that, more often than not, will not work out profitability. Losing even $0.50 on a penny stock could mean a 100% loss.

Overall, remember to think about stocks in percentages and not whole dollar amounts. And you’d probably prefer to own a quality stock for a long time than trying to make a quick buck on a low-quality company (except for professionals, most of the returns on penny stocks can be drilled down to luck).

Going All in With One Investment

Investing 100% of yourcapitalin a specific investment is usually not a good move (even 100% in specific commodity futures,forex,orbonds).Even the best companies can have issues and see their stocks decline dramatically.

Investors have a lot more upside by deciding to throwdiversificationto the wind, but this also carries a lot more risk. Especially as a first-time investor, it’s good to buy at least a handful of stocks. This way, the lessons learned along the way are less costly but still valuable. Exchange traded funds (ETFs) are a great way to get broad exposure.

Leveraging Up

Leveragingyour money by using amarginmeans that you borrow money to buy more stock than you can afford. Using leverage magnifies both the gainsandthe losses on a given investment.

As an example, assume you have $100 and borrow $50 to buy $150 of stock. If the stock rises 10%, you make $15, or a 15% return on your capital. But if the stock declines 10%, you lose $15, or a 15% loss. More importantly, if the stock goes up by 50%, you make a 75% return. But if the stock declines 50%, you lose all the money you borrowed, plus some.

There are other forms of leverage besides borrowing money, such asoptions, which can have a limited downside or can be controlled by using specific market orders. However, these can be complex instruments that you should only use once you have a full grasp of the market.

Learning to control the amount of capital at risk comes with practice, and until an investor learns that control, leverage is best taken in small doses (if at all).

Investing Cash You Can’t Afford to Lose

Studies have shown that cash put into the market in bulk rather than incrementally has a better overallreturn, but this doesn't mean you should invest your whole nest egg at one time.

Investing is a long-term business whether you are abuy-and-holdinvestor or a trader, and staying in business requires having cash on the sidelines for both emergencies and opportunities.

If you only have enough cash to invest or have an emergency cash reserve, then you're not in a position financially where investing makes sense. This kind of investing leads to making mistakes due to behavioral biases.

Chasing News

Whether it’s trying to guess what will be the next "Apple," investing quickly in a “hot” stock tip, or going all-in on a rumor of earth-shakingearnings, investing on news is a terrible move for first-time investors. Investors are competing with professional firms that not only get information the second it becomes available but also know how to properly analyze and act on that knowledge.

Rather than following rumors, the ideal first investments are in companies you understand and have a personal experience dealing with. You wouldn’t keep betting on black at a casino to make long-term profits, so you shouldn’t do what is the investing equivalent.