Following the crowd

Q I read a number of investment articles and, more often than not, invest on the back of investment tips from magazines. Regrettably, I seem to either just 'miss the boat' or the stocks I buy do not materialise into making the riches I had hoped. What advice can you give for avoiding the 'hot tips' and concentrate on common sense investing instead? This applies to selling out at the right time too, as opposed to holding onto a stock in hope for better times.

A Humans are prone to a herd mentality. This is a common mistake in investing also. Imagine if you were part of a crowd caught in a cinema that was on fire.

The people best qualified to get you out safely, such as a member of staff or an off-duty firefighter, shy away from taking the lead because they fear being wrong and they know the difficulties of leading a smoke-blinded group.

Then the 'take-charge' person steps up and everyone is happy to follow the leader. This person is not qualified to get you out of an unfamiliar burning building, so, sadly, you are more likely to perish than find your way out.

This tendency to panic and depend on the direction of others is exactly why problems arise in the stock market, except that we are often following the crowd into the burning building, rather than trying to get out. In investing, two actions caused by herd mentality are:

Panic buying: This is the 'hot tip' syndrome. You see a stock rising and you want to hop on for the ride, but you're in such a rush that you skip your usual scrutiny of the company's records. After all, someone else must have looked at them.

This is wrong and holding something 'hot' can sometimes burn your hands. The best course of action is to do your own due diligence. If something sounds too good to be true, it probably isn't.

Panic selling: This is the 'end of the world' syndrome. The market (or stock) starts taking a downturn and people act like it's never happened before. Symptoms include a lot of blaming and despairing.

Regardless of the losses you take, you start to get out before the market wipes out what's left of your fund. The only cure for this is a level head. If you did your due diligence, things will probably be okay, and a recovery will benefit you nicely.

Gamblers can always tell you how many times and how much they've won, but never how many times or how badly they've lost. This is the problem with relying on rewards that come from luck rather than skill: you can never predict when lucky gains will come; but when they do it's such a treat that it erases the stress (psychological, not financial) you've suffered.

Investors can fall prey to both the desire to have something to show for their time and the aversion to admitting they were wrong. Thus, some investors hold on to stock that is losing, praying for a reversal.

Other investors, settling for limited profit, sell stock that has great long-term potential. The more an investor loses, however, the larger the gain must be to meet expectations.

One of the big ironies of the investment world is that most investors are risk averse when chasing gains but become risk lovers when trying to avoid a loss (often making things much worse).

If you are shifting your non-risk capital into high-risk investments, you are contradicting every rule of prudence to which the stock market ascribes and asking for further problems. Don't therefore let your pride stop you from selling your losers and keeping your winners.

Mark Hollingsworth is the director of Hollingsworth International Finan cial Services - licensed by the MFSA to provide investment services under the Investment Services Act 1994 (IS/32457). Address any financial questions to: Mark Hollingsworth, c/o The Sunday Times, PO Box 328, Valletta CMR 01. Alternatively, he can be contacted on 2131-6298/9984-2614 (office hours) or e-mail mh@hollingsworth-int.com.

Past performance is no guide to the future and, except where amounts are guaranteed, the price of your investments (and the currency in which it is denominated) may fall as well as rise. Your personal tax situation will depend on residence. Always consult a professional adviser. This article does not intend to give investment advice and its contents should not be construed as such. Readers are encouraged to seek professional advice on their personal financial situation.