10 common misconceptions about stocks

Hong Kong people like investing in stocks as a way to grow their assets. According to the IEC Research: Knowledge, Attitudes and Behaviour towards Money and Debt Management, 45% of Hong Kong people had held or traded financial products over the past 12 months. Stocks were the most popular financial product as among them 74% had held or traded stocks.

Investing in stocks looks simple, but in fact there is much to learn about it. The IEC has collaborated with the Hong Kong Securities Association to provide you with 10 common misconceptions to help you get smarter about stocks.

Investment mindset

1. Does initial public offering (IPO) subscription guarantee profits?

The IEC Research showed that 27% of respondents thought IPO subscription was mostly profitable and 55% considered that investing in renminbi (RMB) guaranteed value appreciation. One-third of investors (33%) expected to have at least 20% for their annual investment returns.

According to the statistics, among the 79 IPOs last year, 28 IPOs had their closing price on debut lower than their offered prices. RMB also depreciated almost 4% from February to May this year. The Hang Seng Index rose 2.9% in 2013, while the Hang Seng China Enterprises Index dropped 5.4%.

Unless specified otherwise, profit is not guaranteed.

2. Lack of holistic assessment

When investors assess a stock for investment, they may focus only on the positive news and make the investment without getting grips with adverse factors. Investors should take a balanced view of information from various sources and review in detail to evaluate the investment objectives.

Investment strategies

3. Are the stocks listing on the Main board more fail-safe than those on the Growth Enterprise Market (GEM) board?

The Stock Exchange of Hong Kong (SEHK) sets different requirements eg operation records, profits, market cap etc for the companies intending to list on the main board or on the GEM. View details of basic listing requirement of equities of SEHK.

To assess the robustness of a listing company, one should consider the financial status, industry sector as well as the economic situation of Hong Kong and worldwide, don’t just merely look for information listed on the main board or on the GEM board.

4. Following the herd

Don’t follow the herd and speculate on sectors or individual stocks. For industry sector, you should know about information such as policy risks associated and the future development. For stock, you should understand its profit performance, dividend policy, etc. Avoid counting on investment tips or making investment decisions based solely on the stock codes.

5. Over-concentration of risks

Some investors have their stock portfolios over-concentrated in a few stocks or sectors because of their limited capital. You should avoid putting all eggs in one basket. Diversification help reduce risks. Stocks in the same industry would often follow the same trend, you can also add other asset types such as bonds and funds to help avoid over-concentration of risks.

6. Lack of a stop-loss strategy in making high-risk investments

The IEC Research revealed that 53% of those who had held or traded financial products over the past 12 months did not have a stop-loss strategy, particularly for the female and the lower income groups.

In carrying out high-risk investments through margin accounts, make sure an unequivocal stop-loss mechanism is set up with your intermediary to manage the risks and prevent unexpected loss.

Knowledge of trading stocks

7. Not familiar with liquidating a margin position

When an investor trades a stock through margin financing, if the price of the stock falls to a certain level, the intermediary may issue a “margin call” for further collateral to cover the margin shortfall. Sometimes a brokerage may even liquidate a margin position without making the margin call because in some margin account agreements, even if your brokerage offers you time to raise the collateral in your account, the firm can sell your securities without waiting for you to meet the margin call. Therefore, make sure to check the margin call procedures with your intermediary before you start trading to avoid future disputes.

8. Order price is different from the transaction price

When a stock is dumped in large quantities in the market, prices will dive and investors buying on margin will have to liquidate their positions. Under such circumstances, the final transaction prices of the stock may be lower than the prices of the limit sell orders set by the investors. It is because there are not enough buy orders to cover all the stocks coming from the forced closing out of positions at the prices set.

In addition, the market price of the rights issued to shareholders for raising funds could be different from their theoretical value when the expiry date of the rights draws near and it also changes according to the supply and demand in the market.

9. Must shareholders accept a mandatory offer?

Shareholders can decide for themselves whether to accept such an offer or ignore it.

You should read the offering document and offeree circular before deciding whether or not to accept the offer. Please bear in mind that mandatory offers sometimes come with less-than-attractive bid prices. As such, you should consider the different aspects of an offer in light of your own investment objectives, especially the views of independent board committee and opinion on the offer from an independent financial adviser.

If you decide to accept the offer, complete the acceptance form and return it before the deadline. But if you wish to decline the offer, you don't need to do anything.

10. Engaging in IPO lottery draws through margin borrowing

Subscribing to new stocks through margin financing can increase the chance of getting allotments, but if the subscription response is poor, those who have subscribed through margin financing may have to take up all subscribed shares and be allotted more shares than they have expected. Investors are usually required to pay for the full subscription cost and this may pose financial pressure and thus additional risks to them with all the allotted shares.

On the other hand, if subscription response is robust, investors will only be allotted a small number of shares. The total return after the stock is listed may not be sufficient to cover the interest cost of the margin financing.

Furthermore, if margin financing is used to subscribe fixed income products such as inflation-linked bonds and renminbi treasury bonds, the interest payment for the margin borrowing could be higher than the interest income from the products subscribed.