Learn seven of the most common trading mistakes to avoid. Hone your trading strategies and skills by knowing what not to do.
The mechanics of trading are relatively simple. A click or two gets you into a trade, and a click or two gets you out. But the decision-making process behind those clicks is much more complex. And with complexity comes more opportunities to make mistakes that can affect your bottom line. Here are seven common mistakes that traders—both new and experienced—sometimes make.
Trading can bring out the best and the worst in us. For a trader, nothing is more frustrating than opening a long stock position and seeing the market drop, bringing the value of your long position to levels well below what you bought it for. The same can be said about missing out on a move in a stock that’s been on your radar for a while.
Anger, fear, and anxiety can lead traders to make quick and even irrational emotion-based decisions. For example, if a long position starts losing money, traders may quickly start buying more positions at lower prices or opening short positions on the same stock, just as a way to get even with the market. And when it comes to missing out on a move, traders often make the mistake of trying to jump on a move after it’s already happened ... often at the point when it’s ready to reverse.
The reality is that markets move through ups and downs. Trading decisions based on emotions may not always give the results you want. Instead, take a step back and think through the situation logically. Every situation is different, and instead of buying or selling in a panic, think about how you can best manage risk.
When a position hits a stop order, it can often mean you’re going to take a loss on it. Pulling—or canceling—a stop is often a subliminal attempt to avoid admitting you were wrong. After all, as long as the position is open, there’s still a chance it could come back and be profitable.
The problem is, every 50% loss starts with a 5% loss. It’s not magic; it’s just math. And it only takes one small loss that turns into a big one to make a big dent in a portfolio. Losing is no fun, but it’s part of trading. Being disciplined about managing your stop orders may help you come back and trade another day.
Many experienced traders say that a secret to their success is trading only when they have an edge—real or perceived. An edge can be a viewpoint, such as something in the charts or in the fundamentals that says, “the scales look to be tipped one way on this.” And if a trader doesn’t see that edge in a trade, it’s one to avoid.
Earnings can sometimes fall into that category. Sometimes, no matter what your indicators or charts say, or how well you think you’ve analyzed a company’s fundamentals, a stock’s reaction after an earnings announcement is still basically a coin toss because of all the subjectivity involved. It may be best to avoid trading around earnings.
Every trader has an internal image of what type of trader they think they are. Sometimes that image is correct, but sometimes it’s not. You may imagine yourself to be a fast-paced day trader, but in truth, maybe your personality is better suited for swing trading, where you hold positions for time frames of two to six days or longer. Or maybe you’ve been swing trading and you’d like to pick up the pace.
Trading in the time frame that best fits your personality allows you to be more comfortable and relaxed, which can promote clearer thinking and better decision making.
Traders may use technical indicators to trigger entries and exits to make their decisions more objective. For example, if a stock breaks below a technical level such as a five-period exponential moving average (5EMA), there’s no way to deny it; it is what it is. But sometimes technical indicators can be used to rationalize otherwise irrational trading decisions.
Suppose you decide to sell a stock when it breaks below the 5EMA, and it does. But maybe you’re hesitant; maybe you change your indicator to a 9EMA. And if that’s broken, a 21EMA, then a 50EMA, and so on. You keep giving the stock more room, more chances to avoid taking a loss, using different technical indicators or values to justify your actions.
There’s a fascination among traders about picking turns. Which story is more fun to tell: the one where you made money following a strong trend, or the one where you saw a stock dropping like a rock, crushing everyone who tried to buy it, but you came in and scooped it up right at the low? If you’re like many traders, you’d prefer the second one because it’s a lot more dramatic.
Perhaps that’s why some traders spend a disproportionate amount of time trying to buy bottoms or short tops. Of course, the problem with this approach should be self-evident. If you’re more concerned about how you made money than actually making it, you might be trading for the wrong reasons.
Notice a shared theme among several of the mistakes on this list? It’s “avoiding decisions.”
The proverbial deer in the headlights usually meets his demise because he won’t make a decision. Traders sometimes experience the same phenomenon. Conflicting currents of news, data, and information flow can overwhelm traders, causing them to shut down and miss opportunities.
Heard of “analysis paralysis?” When you’re holding a position, analyzing too many variables can cause you to freeze. It may be better to take the initiative and decide, one way or the other, even if you’re not 100% certain of the right answer. Because refusing to act won’t stop the markets.
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Financial Communications Society 2016
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