CHAPTER 7:
BEWARE – COMMON MISTAKES TO AVOID
Uncontrolled Losses
Too Much, Too Soon
Being Driven By Fear Or Greed
Forgetting To Lock In Profits
No Reentry
Putting Stock In Untested Ideas
Chasing Entries
Overtrading
Eliminating Mistakes
Chapter 7 – Key Points To Remember
We’ve mentioned this before, but it’s something that bears repeating. You’re going to screw up. Not every trade is going to be a winner. In fact, even the best traders in the world only make a profit on a minority of their positions. The difference is that they know how to control the risk, setting up the conditions where their losing trades don’t lose much, and their winning trades pull in big profits.
That’s what you should be aspiring to, and one of the keys to becoming a successful trader is to understand and avoid the most common pitfalls that befall traders of all levels of experience (though obviously, this is skewed heavily toward beginning traders, who tend to make more mistakes!)
We’ve gathered all of the biggest, most common mistakes that traders make, and put them all in one place so that you’re not only aware of what they are, but also know exactly how to avoid making them in the first place. If that sounds good to you, then read on!
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Uncontrolled Losses
This is one of the first lessons that beginning traders need to learn, because nothing will end your trading career faster than uncontrolled losses. The faster you get a firm handle on controlling your risk, the better off you’ll be.
The problem, in practice, is this: A new trader enters a position and he (or she) misread the tea leaves. The market promptly moves the other way. The fledgling trader, convinced that his analysis was correct, stubbornly clings to the idea that he was right, and maintains the position as losses continue to mount, counting on a turnaround at some point to save the day.
Then, the money runs out, and that’s game, set and match.
This is why proper position sizing is so important, but that’s only one part of the equation. The other part is making firm, well-defined rules about when to exit a trade, and standing by those rules, no matter what. That is, after all, why you made them! To protect yourself from exactly the kind of nightmare scenario described above. Of all the mistakes on the list, this one is probably the most tragic, because it can so easily be avoided. Never forget that.
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Too Much, Too Soon
We mentioned proper position sizing in the section above, but it deserves its own section, because it is its own type of mistake.
Too many traders don’t have a firm understanding of how important proper position sizing really is, but as we said, it’s one of the twin keys that help you control risk.
It should be noted though, that the “too much, too soon” mistake isn’t just about taking care not to risk too much of your trading capital on any given position, it’s also about properly controlling your leverage. You should know exactly how much leverage you’re using, without even looking it up. If you don’t, you’re flirting with disaster.
This can be avoided simply by being mindful, and using a simple, rules-based system to help you define the “right” position size for you, bearing proper leverage use in mind.
When you’re first starting out, your trades should be positively tiny, even when you’re convinced that you’re going to make money, because honestly, you just don’t have the tools or the experience to make that call with any kind of certainty.
Even when you have some experience under your belt, you’d be ill-advised to allow any position to occupy more than about 2% of your total trading capital, no matter how convinced you are that it will work out in your favor.
It only takes a few wrong guesses to wipe your account out completely unless you abide by strict rules where position sizing is concerned. Go slow and take your time. Nobody ever went broke by investing too little, too quickly, but plenty of investors have seen their accounts wiped out by investing too much, too fast.
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Being Driven By Fear Or Greed
This is a tough one, because of course, everyone wants to make money. It’s important to understand though that successful investing is a skill. A process. Making money is a happy consequence of mastering the process, but if you’re focused exclusively on dollar signs, then you’re missing the point.
Greed can manifest itself in a number of different ways, but here are the primary scenarios where you’ll see it take hold:
• You see some early success in trading and get cocky, which causes you to forego due diligence and research. Shortcutting the process might work in the short run, but in the longer term, it will kill you. New traders are especially susceptible to this, but traders at any kill level can fall victim to it.
• You enter a trading position, and get caught up in the excitement when the market moves strongly in your favor. The excitement of big gains growing even bigger blinds you to reason, making you forget to take profits, or to keep delaying until it’s too late, and the market starts to reverse course. This variant is seldom fatal, but it will consistently reduce your profits, making you a less effective trader than you could be.
• You get overly focused on the dollar signs, which prompts you to seek out high risk trades, in search of high profits. In your impatience, you forego your risk-mitigation strategies, and before you know it, your account is wiped out. This one can happen to traders at any level, although again, newbies are the most susceptible to its lure. This is essentially a “get rich quick” mindset, and if you have it, you need to beat it out of your system by any means necessary. Again, if you’re focused on dollar signs, then you’re not focused on process, and that will kill you as quick as anything, and quicker than most things.
Letting your emotions run amok is another highly dangerous mistake in the same general category. The clearest sign that you’re falling victim to it is when you start making decisions based on gut feelings. Here’s a hard truth you need to come to grips with sooner, rather than later: No amount of instinct can take the place of hard data and good analysis.
There are two basic ways that getting emotional will manifest: First, if you have a personal connection with a given position. For example, let’s say that you’re an Apple fanatic, and because you are, you buy share CFDs that track Apple stock.
Your emotional connection to the company could easily cause you to ignore your process and buy or hold when you should sell, causing you to lose money needlessly.
The second basic manifestation comes when you suffer a losing trade, and novice traders are especially prone to this. The losses freak you out, making you lose what little investing confidence you had. That, in turn, causes you to freeze when you should act, or to act in panic when you should research or bide your time. Both can be deadly, and see your investment account balance zeroed out in a big hurry.
Both of these things come down to a general lack of investing discipline, and in both cases (greed or fear-based problems), the solution is the same.
Dedication to the process.
That’s the only way you can loosen the grip that your emotions have on you. When you catch yourself getting cocky, or acting out of fear, just…take a deep breath. Remember the process and start marching to the beat of its drum. Do that, and you’ll find that problems like these vanish in short order.
NOTE, however, that vigilance is called for, because fear and greed may be beaten back for a while, but they’re always lurking on the periphery. Always ready to descend on you and control your thinking, unless you’re guarding against them.
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Forgetting To Lock In Profits
We’ve mentioned this before, and it deserves special attention here because this is something that many investors from beginners to intermediate, struggle mightily with. There are a couple of reasons why.
First, when most people think about exit strategy, they tend to think in terms of mitigating losses, but if you never lock in your profits, you’ll never make any money in trading, no matter how good you get at controlling losses, so it matters too.
As you’ve read in previous sections, there are several different approaches you can take to help determine when it’s the “right” time to take profits, and there’s no “one size fits all” answer here. What matters is the fact that just as you define clear and precise rules about how much of a loss you’re willing to take on a position before bailing, you also need to get into the habit of defining clear and precise rules about where and when you’ll lock in profits.
A lot of people are under the mistaken assumption that profit taking somehow runs counter to the mantra of “let your profits run.” The reality is that they’re not mutually exclusive because nothing says that once you exit a trade to lock those profits in, you can’t re-enter and continue to ride the wave if it makes sense to do so, which is our next topic under consideration!
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No Reentry
It bears mentioning again that although many people claim that learning when to re-enter a position is one of the hardest trading skills to master, we disagree.
Just treat it as a discrete event. Close your position when it makes sense to do so, but then, re-evaluate the market landscape to see if it makes sense to re-enter, just as you did when initially evaluating the merits of the position. It’s the exact same steps, performed again on the same target, and as such, is no easier or harder than evaluating any other position you’re considering adopting.
Also note that re-entry doesn’t necessarily mean re-entering the position in exactly the same way. For instance, let’s say you initially bought low, adopting a long position on a particular asset. The market moves in your favor, and when your analysis tells you the time is right and your profit conditions have been met, you sell and lock your profits in.
On further analysis, you reach the conclusion that the price is about to start trending down. That would be a perfect time to re-enter, but via a short position, in anticipation of the price falling.
The key advantage to re-entry is that you’ve already done a lot of the groundwork and due diligence. You already know the particulars of the asset in question, so all that remains is to study the current pricing trends to see what makes the most sense.
In other words, re-entry cuts down on the amount of research you have to do, since you’re already intimately familiar with the asset in question. That makes you a more efficient trader, and very likely, a more effective one too, and that’s a big win.
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Putting Stock In Untested Ideas
Anyone can fall victim to this. You come up with what you think is a brilliant plan, or you adopt a strategy you’ve read about that has worked for someone else and…you do it without testing it first.
That’s not just bad, it’s dangerous. Can you imagine buying a car, if you knew that nobody had bothered to check the components to be sure they wouldn’t explode the moment you put the key in the ignition and turned it?
Testing is crucial! If you aren’t testing your ideas before you implement, then you’re essentially flying blind, and that is a recipe for disaster. Many Brokers offer software that allows for at least some level of back testing your ideas. If your broker doesn’t offer anything like that, then it’s well worth the money to invest in third party software that gives you the ability to do so.
Simply put, proper testing not only allows you to test new ideas, but also to continuously refine existing ones.
Chasing Entries
This is a mistake that almost every novice trader makes at least a few times, early on.
The most common manifestation looks like this: You see a report about a business doing some great, new amazing thing on the evening news. On the basis of the report, you go all in, expecting to make a huge profit.
The problem though, is that by the time the report made the evening news, the information about the company’s plans has been in circulation for quite some time, in the form of various disclosures and reports issued by the company.
In other words, by the time you stake out your position, you’re already late to the party. Many novice traders regard the above as “doing research.” It isn’t.
While it’s true that you might make money on the position, it’s also true that if you’d done some actual research, you would have identified the opportunity much earlier, so not only will your profits be reduced, but your risk will be increased. That’s never a good combination.
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Overtrading
This is a pretty straightforward one. Lots of beginning traders (and more intermediate traders than we’d care to admit) get the idea stuck in their heads that trading is a volume business. It isn’t. You can make a nice, solid income with relatively few trades.
On the other hand, if your investment strategy is sound, then the more opportunities you have to execute it, the better. Just bear in mind that more trading doesn’t necessarily equal better trading. Think quality over quantity.
By all means, go for quantity if your strategy is going like gangbusters, but don’t make trades just for the sake of trading. There are costs involved in every trade you make (brokerage fees, possible financing charges, and the like), and if you start ignoring that fact, you’ll drag down your profits.
This kind of mistake is seldom fatal, but it certainly can be.
Eliminating Mistakes
When it comes to eliminating mistakes, at least half the battle is simply being mindful of them. After all, you can’t chart a course around something unless you know it exists in the first place, right? So step one in mistake avoidance is to be aware that it exists in the first place.
Also note that most of the mistakes here have process-driven solutions. In other words, there are a series of logical, ordered steps you can take that, when performed diligently, will help you avoid trouble. That gives you a powerful one-two punch: Mindfulness and process.
Stick to the process and be situationally aware, and you’ll go a long way toward eliminating the worst of the mistakes, which in turn, will go a long way toward making you a highly successful trader!
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Chapter 7 – Key Points To Remember
• If you want to maximize your chances for success, then before you make your first trade, you should test the trading system you’ve devised both backward and forward (literally!). Something that hasn’t been profitable in the past is not likely to be profitable in the future. Use that knowledge to your advantage!
• While overtrading is great for your broker, it’s not so great for you! If your risk-reward isn’t great, it’s probably because you’re chasing too many marginal opportunities. Learn from that and be more selective.
• Never chase an opportunity. If you know where and how to look, you’ll find plenty of opportunities, and you’ll only increase your risk and decrease your potential for profits by showing up late to the party.
• If there’s one thing that new traders really struggle with, it’s knowing when to cut your losses and get out of a position. This is why it’s so important to get into the habit of placing a stop order every time you enter a position, no exceptions!
• Simple mistakes like transposing numbers, adding a zero or hitting the wrong button can be easily eliminated. This is just a matter of being more mindful and triple checking everything before you place a trade. And don’t forget to review your trades after the fact too! There’s no such thing as being too careful!
• If the market just handed you your butt, it can be hard to get back on the horse and make that next trade. That’s okay, and understandable. Just scale back your position sizes to take some of the sting out and try again!
• Winning trades can be every bit as bad as losing them, especially for beginning traders. Overconfidence leads to cockiness, and that can allow greed to take over. Don’t allow a winning streak to cause you to deviate from the trading plan you have mapped out. If you do, you’ll find yourself taking stupid risks and overleveraging, which can END your trading career.
• If you’re keeping a trading diary (and you really should be!), then use it! That’s what you’re going through the trouble of keeping it for. It can help you spot mistakes or weak spots in your trading strategy.
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