The Most Common Trading Mistakes that Turn Traders into Gamblers
By Kenneth Fisher
Market Analyst
Learning to trade like a pro can be daunting when you start
out. From averaging down to emotional trades, here are 10 of the most common
trading mistakes made by novice day traders.
Emotion is the trader’s worst enemy
Counterintuitive as it may seem, most novice traders hold on
to losses and let go of wins. Which, when you read it out loud, sounds
ridiculous. Yet, several studies have shown that it is the most common mistake
made by traders. So why would we do something so obviously unprofitable? At the
heart of this isn’t some complicated technical impediment to reason. It is
simply our humanity and the completely irrational but understandable fear of
loss.
The principle is simple.
When we start winning, we get anxious about losing our
gains. We close trades prematurely to capture the profit before the price
starts to drop again. We should be holding on to it and closing out just as it
turns, which would maximize the profit.
Conversely, when we start losing, we hold on to the losing
position longer in the hope it will turn upwards at some point. We have the
irrational belief that we will reduce or wipe out the loss.
This is the same principle that casinos exploit to keep
unwitting patrons pulling at the one-arm bandits until their bank accounts are
emptied.
So, even if we have more winning trades than losing ones,
the average size of the wins versus the losses finds us in a net loss trading
position over time.
It is the most basic and destructive mistake any trader can
make as it spawns a host of further blunders that, if remain unchecked, can
become habits that are hard to break. Here are 10 of the most common trading
mistakes made by traders.
1. Unrealistic expectations
A common issue with new traders is how they define success
as a forex trader. Many
enter the field with the notion that they can make a quick buck and essentially
win the lottery every day with a bit of luck. Trading is not gambling. It
requires a key set of skills, discipline, analytic abilities, planning, and a
long-term vision.
Temper your expectations and treat trading as a long-term
endeavor and not a night out at your favorite casino.
2. Trading without a trading plan
Another critical trading mistake is assuming that skill and
practice are enough. When we have no parameters against which to gauge the
veracity of our trading choices, we run the risk of succumbing to our emotions
without even knowing it.
A trading plan provides the necessary foundation on which to
build a consistent growth path towards profitability and includes clear
objectives, strong analysis, realistic expectations of profit (and losses), and
reasonable time horizons, among others.
3. Failure to cut losses
Letting a losing position run in the hope of a turnaround
runs the risk of wiping out both profits and capital. People often ask if day
traders can use stop-loss orders to minimize losses when a position starts to
trend downwards. The answer is yes. Limiting your losses through stops is a
solid tactic and can help maximize the value of your wins over time, but
remember, stop loss orders are not guaranteed to get executed so keep an eye on
your trades.
4. Risking more than you can afford
Apart from minimizing losses and maximizing profits, many
traders forget to manage the risk of wiping out their capital as well. Setting
limits on how much capital you are prepared to risk at any given time is a
useful strategy to stay trading and not find yourself in an overexposed
position. While overexposure can maximize profits, it also amplifies losses and
can signal the shift from trading to gambling.
5. Reward/risk ratios
Once you’ve set your limits and stops, it is important to
understand your overall performance. In your trading plan, you need to set some
goals against a set of metrics. One key trading mistake many traders make is
not monitoring the average loss and profit per trade.
For example, if, on average, you lose $10 per losing trade
and earn $15 profit per winning trade, then your reward/risk ratio is $15/$10 =
1.5. A ratio of 1 is break-even, while anything above 1 is considered
profitable.
This ratio provides an indicator of your overall success as
a trader and does not allow you to bask in the glory of big wins without
assessing them against your losses.
6. Averaging down or adding to a losing position
This is a common mistake made by many day traders who
sometimes use long trading positions to justify holding on to a short-term
loss. The idea is that you buy more in a losing trend so that when the price
“eventually” rises above your opening position, you will maximize your profits
because you bought at a lower price.
As a day trader, you run the risk of the price never peaking
above your original position before the close of the trading day, and you end
up throwing good money after bad.
7. Leveraging too much
Leveraging, or the ability to borrow from a broker to make a
much bigger trade, is very tempting, especially when a trader’s capital base is
small.
The OANDA Trade platform
supports trading with leverage, which means that you can enter into positions
larger than your account balance and trade without depositing the full value of
the position that you wish to open. One of the benefits of trading with
leverage is that you could potentially generate large profits relative to the
amount invested. On the other hand, trading with leverage could also result in
significant, rapid losses to your capital. It is important that leveraging
is done within the limits set in your trading plan to protect the capital
base.
8. Trying to anticipate news events or trends
Once again, gamblers often try to anticipate a trend or news
event and hedge on the potential outcome of that event. A typical example would
be anticipating the announcement of a change in interest rates and hedging that
an increase might trigger a short on a particular currency.
While economic fundamentals are important to understanding
the long game, day trades are more vulnerable to other factors and require
patience before acting, even after the news breaks.
9. Fear of missing out
The fear of missing out, or FOMO, on a big score is often
triggered by a news event or a trending meme on social media. Once again, fear
is the key motive and drives irrational decisions to trade even when it goes
against any parameters and strategies you may have set out in your trading
plan.
10. Too many trades too soon
Diversification of trades can be a good risk-mitigation
tactic. However, diversifying too broadly and too quickly can lead to a number
of pitfalls. Too many trades across a diverse portfolio in a short time frame
can lead to information overload and silly mistakes.
Over-diversification can also lead to correlated trends that
you may not pick up immediately. This simply means that you may believe you
have mitigated risk only to find that your trades are linked, and you’ve
achieved the opposite.
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