3 Wrong Reasons to Buy A Stock

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Reason 1: Because the stock is trading at a 52-week low

There is a famous saying in stock market investing “Don’t try to catch falling knives”. Unfortunately, very few investors have heard of it. Yes Bank stock is a classic example of this. Investors kept buying the stock as the stock started hitting new 52 week lows with the hope of buying low and selling high. The reason behind this continuous fall can be attributed to deteriorating fundamentals of the stock one after the other. Fall of a stock to its 52 week low should never be the reason to buy the stock. There would be a valid reason why the stock price has plummeted, which could range from the company or industry-related dynamics, broad economic factors or change in fundamentals. Not that we are saying every fall is terrible, but what is critical is understanding the reason behind the fall.

Reason 2: Because the stock is available at a very low price

Once in a while, I come across investors who think they have mastered the art of quick wealth creation from stock markets. One such investor, I met a few months back, claimed he had found a masterstroke to double his wealth from stock markets. “I have been keeping a close watch on Suzlon Energy stock from some time. It keeps fluctuating between Rs. 5 to Rs. 7. So I bought one lakh shares of Suzlon Energy at Rs.5 and will sell it at Rs. 7 to book a profit of Rs. 2 lacs” he told me. I have heard similar lines many times over the years from new investors and sometimes even from seasoned investors. There are two reasons why most people are attracted to penny stocks. Firstly due to its low price and secondly due to its wild fluctuations in a very short period. In a single week, shares might go from Rs. 1 to Rs. 2 which makes inexperienced investors think, “If I had invested in that stock, it would have doubled my money in just a week”. In reality, things don’t work out like this. Rather than going from Rs. 1 to Rs. 2, the stock could also go down to Rs. 0.10, which means the investor will lose 90% of his capital. Coincidently this is what exactly happened in the case of the investor I mentioned above who invested in Suzlon Energy. With the stock trading at around Rs. 3.70-3.80 levels, his investment of 5 lacs is now worth only 3.8 lacs. Unlike fundamentally sound stocks which enjoy deep liquidity, at times there are no buyers or sellers for penny stocks. So by any chance even if your investment in a penny stock appreciates, you might not be able to sell it because there are no buyers.

Reason 3: Because I got an exclusive investment tip

There is no dearth of self-proclaimed investment gurus ranging from your friends, relatives or colleagues who are always ready to share exclusive investment tips that can create massive wealth for you. However, that’s not all. There are thousands of stock tip providers out there on social media too and of course the constant bombardment on business news channels. However, it makes no sense to invest on the basis of an investment tip because when you invest based on a stock tip, you know what price to invest and for what target. But what you don’t know is that the actual worth of the stock and reason why its price will move up or down in future. Check out the below stocks recommended by tipsters.


So how does this whole thing work?

A group of operators identify and pick a large number of shares of a company with a very low market cap and then start trading the stock among themselves to create a false impression of high demand. They then spread false news about the stock and fire SMS and Whatsapp messages on how the stock price is going to increase in the next few days. Once their target price is reached, the operators start dumping the shares and exit, leaving innocent investors helpless. Anybody who invests or trades in stocks gets such unsolicited tips. However, smart Investors prefer to stay away from such tips, whereas people who follow tips and invest have lost heavily as these shares have dropped over 80% since their date of recommendation. Often what happens is that when one person invests in a particular stock based on a tip, he also recommends the same in his circle of friends, relatives and colleagues or through Whatsapp messages thus further spreading the incorrect information. So you see these are the worst reasons to buy a stock. On the other hand, the ideal reasons to buy a stock should be its strong fundamentals like efficient and transparent management, consistent earnings, good financial ratios and scalability of business model.

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