Can there be Wrong Reasons to Buy A Stock? Yes! We have three reasons for you.
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 the deteriorating fundamentals of the stock one after the other.
The 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, ranging from the company or industry-related dynamics, broad economic factors or changes in fundamentals. Not that we are saying every fall is terrible, but what is critical is understanding the reason behind the fall. This is one of the wrong reasons to buy a stock.
Reason 2: Because the stock is available at a very low price
Once in a while, you 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 ago claimed he had found a masterstroke to double his wealth from stock markets. “I have been closely watching Suzlon Energy stock for 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. This was an oft-repeated statement many have heard, I am sure from new investors and sometimes even 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 brief period.
In a single week, shares may go from Rs. 1 to Rs. 2, making 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 that. 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, it is exactly what happened in the case of several investors 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, there are sometimes no buyers or sellers for penny stocks.
So, even if your investment in a penny stock appreciates, you may not be able to sell it because there are no buyers.
Reason 3: Because you got an exclusive investment tip
There is no dearth of self-proclaimed investment gurus 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 on social media, too, and of course, the constant bombardment on business news channels.
However, investing based on an investment tip makes no sense because when you invest based on a stock tip, you know what price to invest in and for what target. But what you don’t know is the actual worth of the stock and why its price will increase or decrease in the future.
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 capitalisation 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 send out SMS and Whatsapp messages on how the stock price will 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, intelligent Investors prefer to avoid 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, when one person invests in a particular stock based on a tip, he also recommends the same to 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 business model scalability. We’ve mentioned the 3 wrong reasons to buy a stock.
We suggest you make a note of it and avoid making the same mistakes while buying a stock.