Seven ways to lose money on the Indonesian stock market

Emerging stock markets like Indonesia’s are risky but for investors willing to take a longer term view the potential rewards are tremendous. Shares in Astra International have increased from Rp360 10 years ago to around Rp7,000 today. And Charoen Pokphand’s shares are up from Rp40 to around Rp5,000 today! But investors need to be astute. So avoid the following mistakes!

1) Don’t trade a stock in small amounts frequently. Although not as much of an issue as it once was, trading small amounts of stock regularly will do you no favors as trading commissions have to be paid every time you trade. Furthermore, for less liquid stocks, the gap between the bid and offer price can be quite substantial, meaning that the stock price may need to rise quite significantly before you can even break even. Trade infrequently and in stocks that you believe have good prospects over the longer term and avoid making impulsive purchases based on emotional reasons.

2) Don’t buy a stock based on a hot tip. Just because your best friend says a stock is going to do well doesn’t mean that it will! More often that not these hot tips are also highly speculative in nature: still remember that gold miner which “discovered” huge amounts of gold reserves in Kalimantan?

3) Don’t buy a company which is not profitable. Whilst it is possible to make money by purchasing companies which aren’t very profitable, it is far better to invest only in successful and profitable companies with good long-term prospects. Personally, I will only consider investing in a company if it has ROE (return on equity) above 20 percent, solid gross margins (above say 50 percent) and good net profit margins (above 10 percent). Revenues should also be trending up over, say, the last five years. Buy companies which are market leaders and avoid companies operating in highly competitive and fragmented sectors where there are many players – like tire manufactures for example.

4) Don’t buy a company whose shares have declined solely based on the belief that the stock will rebound. This is an easy mistake to make but you are playing with fire if you purchase a stock which has steadily declined over a period of time. This is because if a stock is trending down then it is probably more likely to stay on its downtrend than it is to rebound. Stocks generally move in trends. Remember that and look at the charts.

5) Choose NOT to invest in the stock market. Shunning the stock market will almost certainly translate into HUGE opportunity losses. Remember money in the bank earning interest at 4.5 percent is dead money. Over time, you will even be worse off thanks to the pernicious effects of inflation. Stock prices can be volatile of course but over the long term they tend to follow the trend set by economic growth or GDP. So if the Indonesian economy is growing by 6 percent, in nominal terms GDP will be growing by at least 10 percent (real economic growth + inflation). You should at least get this return from stocks over the longer term (5-10 years) – and probably a lot more.

6) Fail to diversify. You’ve heard it before: don’t put all your eggs in one basket. But how much diversification do you need? Read about that here.

7) Invest in a “family” business rather than a professionally run company. Investing in family companies is very risky. The business may look good but they may manage it badly. Family squabbles and personal issues can devastate a company. And who’s to stop them dipping their fingers into the cash register if they need some money? Thankfully, though, many of the larger family companies listed on the Indonesian stock exchange have been transformed into modern companies run transparently by professional managers.

8) Buy for short-term gains rather than the long-term. As an emerging market, Indonesian stocks are much more volatile than stocks in developed markets like the US or the UK. If you buy hoping to make money in the short term (6-12 months), there is a good chance you will be disappointed. But over the longer term (5-10 years), Indonesian stocks are much more likely to continue trending higher. Well, in theory anyway…