The stock market can be a minefield if you engage in risky behavior. Photo: Mary Wareham, Flickr
If you want to build a big nest egg for retirement, it's hard to beat the stock market as a wealth-building tool. Investing in the market isn't a guaranteed way to make money, though: If you aren't smart about it, you can lose all of your money in it -- or even more than that!
Here are three ways to lose money in the market. Learn more about these minefields so that you can tread carefully around them.
Matt Frankel: Many inexperienced investors believe the best way to make money in stocks is to day-trade, or to trade with short time horizons in mind. This is 100% false.
For one thing, it's impossible to know what a stock is going to do over the next few minutes, hours, or days. Even if the charts look great to you, any one of many possible events could occur and cause you to lose money. Bear in mind, too, that Wall Street professionals have trading systems that can react to patterns and movements in stocks much faster than you can.
Still, let's assume for a second that you're pretty good at trading, and that your trades don't lose money. You still need to overcome the cost of the commissions tied to your frequent trading, which can add up quicker than you may think.
Let's say that you complete 20 round-trip trades each day, and that your brokerage charges $10 to buy or sell a stock This means that you are paying $400 per day in commissions alone, which translates to $100,000 over the approximately 250 trading days each year. In other words, you'll need to make a six-figure profit just to break even as a day trader.
The bottom line: Leave day-trading to the professionals. The best way to make money in stocks is good old-fashioned buy-and-hold investing.
You might as well set your money on fire instead of daytrading. Image: TaxRebate.org.uk
Brian Feroldi: One surefire way to lose a bundle in the stock market is to recklessly use leveraging instruments such as options without knowing what you are doing. Many inexperienced investors are sucked in by the allure of options because of their ability to magnify short-term gains, but all too often they fail to remember that they can amplify losses, too.
Mind you, options themselves are not the problem. Options are just an investing tool and they're only as dangerous as the person using them chooses to make them. In fact, when used properly, options can actually be a great way to reduced the risk of your portfolio by employing simple strategies such as writing covered calls or selling puts.
I myself regularly use options as a complement to my long-term investment strategy, but because I know that they can cut both ways, I try to be very careful when I buy or sell them. Being careful has saved me a bundle. For example, I recently had an options trade go badly against me on energy giant Kinder Morgan (NYSE: KMI), as the company's stock went into free-fall over concerns that it wouldn't be able to pay its dividend. My bullish options position on the company magnified my losses, but because I kept my overall exposure to this position small when compared to the rest of my portfolio I was easily able to survive the (hopefully temporary) storm. Had I been more rash with their use, I could have put myself in a terrible financial position.
Recklessly using options can badly damage your portfolio, so if you are considering using them, make sure you fully understand what will happen to you if something unexpected happens -- as sooner or later that's bound to happen.
Selena Maranjian: A great way to lose a lot of money in the stock market is to short stocks without really understanding how shorting can serve you -- or ruin you. Permit me to explain. When you aim to make money in stocks, you can do so by being "long" or "short" on stocks. The way that most of us invest in stocks is by being long: We buy shares that we believe will increase in value, and we wait for them to do so.
There's a way to make money on stocks if you're a pessimist, too, though, and that's by shorting. Imagine that you think shares of Scruffy's Chicken Shack (ticker: BUKBUK) are very overvalued and likely to fall in value. To short the stock, you would have your broker borrow some shares from someone else's account and then sell them. The idea is that later, when the shares have fallen, you can buy them on the open market for less and replace them. Thus, you've still profited from the "buy low, sell high" principle, but have just reversed the order, first selling high and then buying low. It all can sound a bit shady and possibly illegal, but it's legal and frequently done. And it is a way that some successful investors make money.
That said, it's often best to just steer clear of shorting stocks -- because they won't always fall in value as you expect. If you're long a stock and it falls from $50 per share to $0, you can lose all your money. If you're short a $50 stock, though, and it triples in value, you will be having to replace it at some point for much more than the $50 you pocketed when you shorted it. There's more to learn about shorting, if you're interested, but just know that you can do quite well in the market without engaging in it.
