The following is a guest post from Ben Carlson at A Wealth of Common Sense. Ben writes about personal finance, investments, investor psychology and building wealth using your common sense.
“There’s no way that you can live an adequate life without many mistakes. In fact, one trick in life is to get so you can handle mistakes. Failure to handle psychological denial is a common way for people to go broke.” – Charlie Munger
Most investors focus on how to choose winning investments by making the correct moves all the time. You should actually be happy if you are right just a little more often than you are wrong. One way to increase your odds of success is to instead focus on your mistakes. Admitting your mistakes and working on minimizing unforced errors will help.
Here are some of the biggest mistakes stock investors make when investing in stocks.
Buying Based on a Story Instead of Fundamentals
Investors love to buy a stock that has a great story. It’s sexy to talk with your friends and colleagues about innovative products, growth and revolutionary CEOs. These attributes get us excited about certain stocks.
Just don’t confuse excitement with value. It’s great if you find a stock that has a story, but make sure it has the fundamentals to back it up. In most cases the story has been baked into the price long before you came along to invest in the company. Remember that great companies don’t always make for great stocks if you buy at the wrong price and terrible companies might make for a great investment at the right price.
You should make your purchase on the basis of the fundamentals of the business using a wide variety of valuation methodologies (P/E, P/B, P/S, BV, FCF yield, DCF, dividends or whatever you determine to be important). Also, make sure to buy with a margin of safety in case your analysis proves faulty. As with all financial models – garbage in, garbage out.
Not Defining Your Time Horizon
I feel that the biggest edge that individual investors have over Wall Street is the fact that we don’t have to worry about short-term performance or benchmarks. Wall Street must play in the week to week and quarter to quarter time frame. They must produce results or have their investors look elsewhere. This can lead to big time career risk if they continue to underperform, which causes them to focus on short-term performance.
Individual investors have the luxury or being able to think and act long-term with their stocks. We don’t have to beat the S&P 500 every quarter or calendar year. We have the ability to be patient. Just make sure you know what your time horizon is before you buy a stock so you don’t make unnecessary moves at the wrong time.
Not Having an Exit Strategy
Buying stocks can be difficult, but the majority of the time, stocks are rising. Therefore even though there are a wide range of factors that you must consider before making a purchase, it’s not the hardest part of the stock investing equation.
It’s actually much harder to determine when to sell a security. We’ve all heard war stories from investors that sold too quickly or didn’t sell soon enough.
The sell decision also has to do with your time horizon as an investor. Are you a long-term holder? A short-term trader? An opportunistic investor in periods of volatility?
You must determine whether you will leg into a position over time, buy the dips in price, invest all at once to buy-and-hold or trade around your positions by taking occasional profits. Knowing this ahead of time will give you a better idea about how to handle your sell rules.
Most successful sell rules involve basing them on a rules-based approach. This could be a valuation target such as the P/E multiple over a predetermined long-term average. Another option would be to sell when the dividend growth rate falls or the dividend gets cut. There are tons of data points to choose from. Just make sure the fundamentals you use for your buy decision are the same ones you use for your sell decision.
Not Having a Reaction Plan
Most investors assume that their actions are the most important aspect of their investment plan. Actions are important, but it’s actually your reactions that make the biggest difference in the long-term.
You need to have a process in place that helps you determine what to do in periods of volatility on both the upside and the downside.
What would you do if the stock you just purchased rose 50% in a month? Would you take some gains? Sell the entire position? Continue to hold for the long-term?
What if it dropped 50% in a month? Would you buy more? Get rid of it entirely? Hold tight?
Having a plan in place before you make a purchase can help temper your reactions. It won’t always turn out to be the best move and it could be different for each investment, but having a consistent process will take away some of the guess work when markets get crazy.
Summary
Everyone makes mistakes when they invest. It’s the nature of the beast when you are dealing with complex markets full of people and institutions that all have different goals and objectives.
Minimizing the big ones will give you a higher probability for sustained success in the long-run. Sticking to the fundamentals, having a long-term time horizon, developing an exit strategy and creating a process to deal with how you react to uncertainty can help you avoid the mistakes that most investors make time after time.
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If you want to know where to go next, which stocks to start with, I would recommend you an e-book by a fellow blogger 
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