Sunday, February 19, 2006

Mistakes cost us Money!

It has been mentioned many times that when you 'play' the share market you need to pay tuition fees. And making mistakes is how one learns to be better in the share market. Pay to learn is what they teach you.

But if one pays too much and too often, isn't there a chance one might just quit the game? Who wants to lose all the time? And if one quits, what about all the tuition fees paid? Or what if one pays so often that it wipes one out financially?

Ah... this is why limiting the cost of one’s mistakes simply paramount to one’s financial health.

And one does that by learning from one's mistakes and better still, we try to learn from other people's mistakes.

Making a wrong judgment is so easy.

Remember always, we are just normal investors, normal investors who would always make mistakes!

So what is a wrong judgment? Say you invest in a stock and the simple reason is that you expect it to be making more money each year. Now, upon studying the evidence given to us via the current quarterly earnings announcements, we discover that the company is not making more money but instead it is making so much less money each quarter. You expected the company to make more money this year but it did not. Instead, the company's earnings have declined drastically. Doesn't this mean we are wrong? Look at it, for whatever reasons, the stock's earnings are not growing but instead its earnings are declining. Do we want to admit we are wrong or do we take a self-denial approach and give ourselves personal satisfaction by insisting that we are still correct? And perhaps we would take extreme measures such as finding various (wrong) reasoning to justify to ourselves that it wasn't us that were wrong but it was due to some unforeseen circumstances beyond our control that made our stock selection not correct for the time being. But hang on a minute here. Whether it was us that were wrong or not, it matters not, we are still holding on the ticket(s) to a stock whose earnings are declining drastically. And the market it compounds the matter worse by punishing the stock via heavy selling. How? Do we want to be in a situation where we get punished so drastically that it wipes us out of the game? No possible?

Or how about we invest in a stock because the company is making a massive plant expansion and through our own reasoning, we believe this plant expansion should reward us handsomely. Well, that is a valid reasoning to invest in a stock. But what if the plant expansion runs into massive problems? Such as, we did not foresee a drastic increase in borrowings to finance the plant. Or for some reason or another, the plant is still not completed. Or when the plant is completed, the economics of the product which the plant produces changes drastically? For example, the product could go out of favor or the product faces new intense competition by other plants or perhaps a new substitute product has been accepted by the market. Cutting it short, what if this plant expansion is not going to be as rewarding as what we ass-u-me it would be? Isn't it possible that we could have a brand new plant but insufficient business to cover the cost of this investment to build the new plant? How? Once again we are wrong. We had bet the plant would deliver but it did not happen. Is the best move to accept that our speculation that the new plant would bring more profit is simply wrong? Or do want to take the self-denial approach by hoping that the fortune of the plant would improve in the future? Ah, it is possible but look at what we are doing. Instead of investing, we are now hoping that the market would correct our investment mistake. What if we are not lucky enough? Would the market punish us by wiping us of the game?

Remember if we are really wrong, and no matter how much longer we wait, we are still wrong!

In the share market mistakes costs us money.

So how big a mistake do you want to make? And how costly a mistake do you want to make?

Don't we want to make sure that our mistakes don't wipe us out?

Remember the idea is to find ways of controlling our risk so that, if we are wrong, we don't get killed.