Trading Mistakes: what are they and how to avoid them

(Video Transcript)

Do we rely too much on data to get our price?

Hello, I'm Angeline Ong, and this is your latest installment in IG's Trading Mistakes series. In this episode, we're joined by IG's chief market analyst Chris Beauchamp, who's going to look at three key topics for us; over-reliance on data, interpretation and the lack of fundamental analysis.

AO: Chris, let's just start off with the first one. There's a Securities and Exchange Comission (SEC) rule which requires funds out there to tell investors not to base their expectations of future results on past performance. Is this linked at all to this potential mistake?

CB: I think it is. Often, you see, with fund managers, people are drawn to the best performance, but that's very much a backward-looking thing. And then you often find that people, and the ARK ETF (exchange traded funds), of course, the tech ETF, is a classic example of how people chase the best performance, and just almost at the peak. And then this is followed up by long periods of under-performance.

Ihe problem with market, and the way charts work, is that everyone looks back to see what happened. And it's very hard, obviously, to look into the future and think what happens next. The human mind also tends to predict what's coming on by looking at what's happened before, really.

Old-school approach doesn't always pay

And so this kind of looking backwards, even when you're trying to look forward, tends to then influence people in their investment decisions. Sometimes it works out. And those trends that people invest in, go on, and on, and on, and do really well. And other times, you maybe catch it too late, or you end up simply being caught out, really.

AO: So how can investors mitigate against this? How can they avoid falling into this hole?

Sentiment peaks, crashes with the market

CB: Well, it's emotion... There's a push to go with the crowd, so we talk about the wisdom of crowds, which is not necessarily the case in markets.

Sentiment peaks, just as bull markets tend to peak, if you like. If you look back at 2021, where markets reached their recent highs before the big sell-off last year, there was a sense that sentiment had become very bullish. People thought the earnings would improve, that markets would rally. And, of course, we know what came next.

Conversely, at the trough and at the lows, you can't find any buyers. And the sentiment sort of hits the lowest level, if you like. And then if we look back to 2022 and the last few months of that year, you couldn't find anyone who wanted to be long retro at the low levels. The stock hits in Q4. And then suddenly, you had this huge rally, mainly because sentiment became too bearish.

Guard against investment extremes

So it's important, I think, to guard against the extremes when you're investing and when you're trading. Whenever I wanted to buy something, made me think carefully about it. Whenever one says it's going to keep going down, it pays sometimes just to be a little bit contrarian.

AO: And this links to our next topic, interpretation. For example, we're seeing markets now grind higher. And there's a lot of uncertainty out there. And at the same time, we have inflation still not coming down. How should investors tie all this together so they cut out the interpretation?

CB: Everyone has an agenda. I think everyone looks at data in their own way, and they filter it through their own mindset.

Most people see what they want to see, whether it's an investor who's bought a stock and it keeps going down, and you think, well, it gets cheaper and cheaper and that's a good thing, because obviously, it's a bit more of a bargain the lower it goes, or whether you're looking at the inflation data and saying, this means markets must do this.

This is, I think, the problem that we see across the client base. People look at markets, and they say, I think this should happen. And they come to that conclusion based on doing quite a bit of analysis, maybe, but they don't look at the whole picture. And they don't look at the alternative case sometimes.

I think then they say, oh, this must happen. Therefore, the market must go down. Or they think, I want this market to go down, or indeed, go up. And anything that happens will automatically fit into my thesis quite nicely. Markets are never that simple. This is hard.

Look at central banks over the past two years. We went from them saying inflation will be transitory to inflation will be stronger for much longer than anticipated. So everybody can be tricked, if you like. Yes,

Dot.com bubble a warning

AO: That's right. I remember not so long ago, quite a number of houses saying that we could potentially even see rates cut, rather.

And of course, inflation has been very stubborn in coming down. And last but not least, the lack of fundamental analysis. I mean, can we tie this to any historical event like the dot-com bubble that gives us a good example of how investors should try and guard against following the herd?

CB: Dot-com is perfect. It's the one that everyone looks back at. Because you had the mania, the frenzy, people investing in these companies that they were convinced would change the world at these astronomically high valuations.

Because you see other people investing and making money. And human nature being what it is, you want to join in on that. And usually, a lot of people end up joining too late. It's the same with a lot of other companies at early stages. They have huge growth, and then it slows down. And you've missed, if you like, the initial bounce, really. And people sort of want to be sucked in.

The irony, of course, with dot-com is that eventually a lot of those companies did end up changing the world. It was just maybe 10 years later. And it was important to look at the valuations.

I think the problem now is we talk about tech stocks and the strength we've seen over the last five years repeatedly with this sector. And people say, it's dot-com all over again. But the world is so different now. And those companies are so different now. Most of them, the really big ones, are so much more profitable that there's a reason why they're so strong.

This isn't dot-com. Everyone's looking for the next 2008 as well sometimes. And they see it, perhaps, in housing data or in car loans or, indeed, in central banks and their rate hikes. And they say, this will cause the next 2008. It's important not to try and fixate on examples from history and look at the data you have in front of you.

AO: And finally, if you had to choose one, what would be your top tip to investors out there trading right now where we are in this period of time when everyone's talking about AI and everyone's talking about potentially high inflation here to stay?

Get ready for the AI frenzy

CB: Don't assume either of those things will remain the way they are. I think AI has exploded in popularity, and maybe rightly so. But again, it's one of those things that is beginning to go into a frenzy. Google searches for AI are at record highs.

People look back over the last year and beyond and say inflation is going to remain very, very strong. Maybe it starts to weaken from here. We don't know. I think whatever you're looking at when you're investing or trading, try and remain almost skeptical of a lot of the things that are being talked about at this very moment in time.

AO: Unfortunately, we have to leave it there. My thanks to Chris Beauchamp, IG's chief market analyst, talking with us today about some of the common trading mistakes and, more importantly, how to avoid them.