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Sad Cases of Investing Gone Wrong

How do stocks work? The main reason that this site exists is to try to educate about the stock market. A fundamental lack of understanding how the market works can easily lead to financial disaster. We know of many search personal cases. A few examples follow, with the names and exact details changed. From these example, you will better see how stocks work.

"Cisco is a safe investment"

During the dot com bubble, Joe got 1% of a startup. It IPO's and he was instantly worth 20 million. When he could sell his shares, he tried to be prudent. He realized the the stock price of his new IPO's company could easily plummet (which of course it did) so he decided to trade it for something he thought was safe, or "safe enough". He traded it for stock in Cisco. Then Cisco plummeted and his tax bill was larger than the value of his stock. The problem was that he underestimated the volatility of Cisco. Joe lost everything and had to declare bankruptcy.

Why did Joe do this? Why didn't he just take his 20 mil and put in T-Bills? If he did that, he'd still be rich today. Was he so greedy that he didn't want to forgo the extra potential gain you were getting back then in the stock market? He could've at least put 5 mil in T-Bills? The answer is probably that he didn't fully appreciate the risk associated with the volatility of an individual stock. Even if he put it in a portfolio of stocks, say Cisco, Intel, Microsoft, and HP, he would have lost big time as well. What can you do about this? This site has free secure software you can download by registering to better educate yourself on volatility and understand the idea that different stocks correlate with each other. This should help you greatly in understanding the nature of the problem that Joe faced and the nature of the steps you'd need to take to lower (but of course not eliminate) your risk. Joe didn't understand how stocks work.

"I'm right all the time"

A math postdoctoral researcher, Mike, at a prestigious academic institution, got into trading futures. He came in every day and make "virtual" trades. He wouldn't actually put in money, but just see if his trade made money or not. After doing this for months, he thought that he got really good at this and was amazed that he always seemed to make the right move. So he decided to go around to professors, researchers and even students, and convinced a lot of them to all invest with him together. They lost everything and in fact owed some money. Everyone was very angry at Mike, and Mike couldn't understand what was going on.

What was going on? Well it was the same thing that happens to gamblers. They only see the times they make money, and find excuses for the times that they lost. Somehow, Mike was so eager to make money, that he managed to overlook in his own mind, the times that his virtual trades failed. He had excuses to discount these, as being special cases of one sort or another. Like some catastrophic news that he simply couldn't have known about, but was exceedingly unlikely. So he only counted the cases that went his way. Those were all due to his business acumen. The other cases where he lost, he didn't really keep proper track of. On average, tossing a coin would have made as much money as Mike's reasoning. Even though Mike was incredibly intelligent, his wish to win acted as blinkers and prevented him from understanding the basics of the whole game. Mike didn't understand how stocks work.

"I definitely make money trading stocks"

A dot-com programmer, Sally, makes a few million as an early employee of a company that gets bought. She decides that she probably has enough to retire, so she goes off to live a great life, relaxing, dining out, biking, traveling. She's very generous with her fortune, helping her family, for example, buying them a house. After a few years, she realizes that her total worth is dwindling. Instead of cutting down on her expenditures, she thinks she has a better idea: trading stocks. She really gets into it. She sits at the computer researching stocks, and buying and selling them. She gets really good at it, at least so she thinks, because her balance is going up. Occasionally she makes a poor decision, but then makes up for it and ends up making more money. "You need money to make money, and I have money, so I can make it!". She is stoked. Well then the stock market takes a turn for the worse, and things start going sour really fast. Then she decides to start shorting stocks. This way she makes money when stocks fall instead of rise. For a while this seems to work and she starts eating out more, but still she's only worth about a third of when she started retirement. "How did that happen?" she thought. Somehow the trades that went wrong, didn't get weighted heavily enough in her head and it never really seemed to her that she was losing as much as all that. Still the bottom line of her accounts had plummeted, as clear as day. What could she do? It'd been seven years since she'd worked. She couldn't easily go back to work anymore, even at an entry level job. So she started even riskier trades. Even though a lot of the time they worked, often they didn't and she ended up losing everything, and having to dip into her mothers retirement fund (which she had been managing) to support herself. Sally didn't understand how stocks work.

Is it all bad luck?

Were these people just unlucky, or were they deluded in thinking that their investment decisions were sound?

The bottom line is that they were all poorly informed. This is not how the stock market works. These cases illustrate a fundamental lack of understanding how the stock market works and how to make investments.

This is not helped by all the misinformation on the stock market on a huge number of websites, making you think that it's possible to do make piles of money with some proprietary investment technique. Despite all the snake-oil out there, don't fall for it.

So this all seems quite gloomy, and you're saying, "but I want to make money, tell me, how do stocks work? There's got to be some disciplined approach I can take".

Yes there is, but it's not going to make you an overnight millionaire. But unfortunately nothing except incredibly good fortune is going to do that.

Invest in a way that will try to reduce your risk and go for the long term. Not some overnight get-rich-quick-scheme.

To properly understand how to manage risk in your investments, we have provided you with a very neat program with 2D and 3D graphical visualization that you get for free with registration. It should help to educate you about risks so you can stop wondering "how do stocks work" and move on to investing wisely.