All of us make them to a certain extent. I am talking about common trading mistakes. In this blog post, I compiled a list of the 7 most common and most costly mistakes that traders are often inclined to do. Funnily enough, it is not just beginners who are prone to them. Just making sure you avoid all seven of them, as listed below, should significantly improve your investment track record. If you don’t make any of them, congrats!
1) Trading too much
I put this as number one mistake because I didn’t yet meet a trader who never slipped into overtrading. The reasons behind trading too much are various. Some people hurry into a new position to recoup recent loss. Others simply can’t exercise self-discipline and jump into a new position out of pure boredom.
If you are guilty of this super common mistake, you are treating the stock market as a casino and if you are not losing yet, it is coming your way soon. While there is no universal rule that would say how much is too much, I would be suspicious every time you buy shares which don’t meet your original strategy or every time you go straight from one position into another.
FOMO (fear of missing out) is another common denominator among hasty investors. Just accept that sometimes the best return you can get in a given moment is 0. Avoiding potential loss might not be as exhilarating as market gains but it serves you well.
2) Bearish bias
Not everybody has this problem but it is still surprisingly common. In the long term, stock markets keep going up. In a way, this makes them look like “overbought” or “in bubble” quite often. So frequently, traders keep trying to call the peak, just because stocks are “too high.” This is a loser’s game.
Antidote to this costly mistake is surprisingly simple. Go over your past traders and count how many times you were long and how many times short. Then count the success rate of your long positions and short positions. This will tell you if you suffer from bearish bias. If the answer is yes, make a commitment to go long at least 60% of the time.
All the above is especially true when we are talking about stock indexes. Those go down rarely and so far recovered every time. Of course, if you are specializing in shorting distressed companies, the story might be a little different there.
3) Reversal bias
Third mistake is so similar to the second and in a way it is it’s opposite. Same as some people keep calling “tops” just because the stock index is already high, many love to call “bottoms” just because “how much lower this old company with a nice dividend yield can go?” Believe me, many went all the way to zero.
It looks to me that reversal bias is a very “generational” problem. Age groups that already experienced a strong bear market are less inclined to it but newbies? Not so much. And I have a proof for my theory (as always). Just look at the most popular companies on Robinhood trading app, investing tool so popular among millennials and first-time traders. What do they have in common? Basically everything in the top 5 is either a fashionable stock or a hope for reversal. Right now (November 19, 2019), Ford, GE, GoPro and FitBit are all close to their 5 year or even all-time lows. The latter two combine fashionable and distressed but I personally wouldn’t touch them with a ten foot pole.
If you are guilty of a mistake #3, you most likely know it. It is part of your cherished strategy. How does it work for you? If you keep struggling in the market, although you keep executing only perfect reversal patterns, try to go with a trend couple times for a change. You will see how much easier it is to make money.
4) Choosing wrong stop-loss levels
This is surprisingly common not only among beginners. You should consider at least two things when placing a stop-loss. Firstly, how much can you afford to lose on this particular trade? The answer should always be a fraction of the potential profit, in case you are right. I will leave the details on you but having stop-losses at 70% of target gains will never work. You would have to be right too often in order to stay profitable.
Secondly, does your stop-loss make sense in relation to the chart pattern you are trading (assuming you are deciding at least partially based on technical analysis)? There are many factors coming into play. Size of the pattern. How much against you would the price have to go, to negate your buy signal? If your stop-loss is closer than that, it is too tight and you can be easily kicked out of position by a price fluctuation only to see the stock continue in your expected direction. That sucks a lot! Some formations might be too big for your account too place relaxed stop-loss, just avoid the unnecessary mistake and pass on those. Similar situation arises when you place stop-loss close to major support or resistance level. Again, you might end up with tour stop-loss being activated only to watch reversal right after you were kicked out.
5) Not reviewing past trades
I already touched upon this when I suggested how to see if you suffer from bearish bias. From time to time, you should review all your trades, winners and losers, and see if you can spot a repeating story. People who are not doing this, are making huge mistake of passing up on a free education.
It is not only free but also tailored specifically for you and your shortcomings. If you keep checking back and learning your lesson, you should be profitable. Because, broken down to basics, only one of two things can be going wrong. Either your losses are too big compared to your gains, or you are losing too often.
In the first case, your money management is faulty. You are either taking profits to soon (you scary kitty), or you are letting losses go too far (you pigheaded fool). In the second case, your buy signals suck or you are trading too often even other setups than you planned in advance. Just dig deep and make an honest session with yourself. There is no shame in admitting that you made a mistake. Just fix it before the next trade.
6) Chasing the latest idea instead of perfecting execution
I was doing very well at one point, trading according to my strategy and it got almost boring to earn money. Then I spotted this small company in long-time low and I caught temporary reversal bias. My loss from this adventure erased gain from several of my profitable trades. I returned to my original plan, again doing well, until Robinhood added feature that allows to trade options. I jumped right in and lost 25% in one trade. Oh yes, stock options are volatile as hell and they have huge spreads between buy and sell.
I think you got the message. Stick with your boring plan instead of chasing the latest shiny object. And I don’t care if the thing that sparkles is an IPO, penny stock, options, foolproof tip from you cousin, or something else. Most likely it is not worth it. In cases like these, I consider losing money early on as a blessing in disguise. It saves you time you could be perfecting a long-term strategy.
7) Jumping into next trade before you psychologically recover
Last but not least, number seven is here to remind you how vital part of your stock trading should the proper mental hygiene be. Money is a very emotional topic for all of us, beginners and professionals alike, and big losses but also big gains can affect your ability to see clearly.
Brave thing is to acknowledge that fact and, instead of trying to ignore negative feelings or excitement, take a pause until you can make the next decision without having your judgment clouded by emotions. So many people keep pushing after they just been emotionally scarred and as a result, they either hurry up to make up for recent loss or end up in second-guessing every pattern until the opportunity disappears.
Surprisingly enough, big profits can hurt you as well. After especially long streak of uninterrupted wins, it is hard not to get cocky. Just accept that a certain level of luck is involved and 10 perfectly executed trades in a row do not make you necessary an investment genius.
If you steer away from all 7 common mistakes outlined above, you should have a solid foundation for being profitable even as a beginner.