Trading is simple, right? Prices go up; prices go down. All you need to do is pick the right moment and watch the money come in. Not so fast!
The world of trading isn’t simple. Even when traders have great ideas, but don’t prepare and execute properly, they usually end up losing. What makes traders successful is recognizing their mistakes, which is the first step to avoid making them in the future.
All traders will have made mistakes at some point in the past – and you are most likely to make mistakes when you are new to trading.
While all mistakes can be costly, some are more costly than others. Read on to find out what the most common trading mistakes are, and how you can avoid making them.
The 3 Most Common Mistakes in Trading
1. Not Using a Profitable Strategy
It is always amazing to see how many traders read about a strategy, then begin to trade it without back testing it. They have no idea whether the strategy has been profitable but go ahead and use it anyway.
Of course, back testing can be very tedious. Yet if you are using a strategy that has not been profitable over recent years, why would you expect it to be profitable this year?
Contrary to what many think, profitable strategies are not hard to identify. For example, diversified trend following has been extensively studied and found to be profitable over the long term, which can be proven statistically.
Back test your strategy over hundreds of trades years into the past.
2. Revenge Trading/Breaking Your Rules
Everyone hates losing, but one of the most common trading mistakes is “revenge trading”. It's easy to want to get back in there and regain your losses right away. However, such emotionally-driven trading is never a good idea – especially when it breaks your own rules about when to enter a trade.
When a trade doesn't work out, the most important thing you can do is analyze why, and then patiently wait for the next qualified opportunity according to your rules.
If you find yourself unable to prevent revenge trading, try taking preventative measures to stop yourself from breaking your own trading rules in the first place.
3. Not Using Stop Loss Orders
You wouldn’t drive your car if you knew there were no brakes. The same goes for entering a trade without setting an emergency brake in the form of a hard stop loss order.
Other Common Trading Mistakes
Here are some other trading mistakes to avoid:
1. Letting Losers Run/Averaging Down
Successful traders and investors know when to take a loss. They know that accepting a small loss is better than letting a losing trade spiral out of control in the hope it will somehow recover and come back to the entry point.
Of course, much of the time, if you average down, it will work. The problem is that eventually it will fail spectacularly, and your catastrophic loss will be bigger than what you would have lost if you had just used stop losses on your trades.
2. Using Too Much Leverage/Margin
Leverage, if used carefully, can accentuate your winning trades, but it can also expand your losses. It is a double-edged sword.
It is important to remember that leverage isn’t free. Remember also that a company leveraged at more than 1.3 to 1 in the corporate world is usually considered overexposed. Now think about that “low” 30:1 leverage available in Forex within the EU.
3. Believing Tips
Experienced traders know what they're looking for and what to avoid. They have a plan and don’t need to look for tips – other traders telling you when to buy and sell.
Taking a tip can feel good because it absolves you of the responsibility to decide when to buy or sell. The problem is, if you don’t have your own conviction about the trade, how are you going to feel if it turns into a loser? Like an idiot, probably, and that will dent your confidence and probably make you a worse trader over the short term.
Tips can come from pundits on TV or social media. In some cases, you might learn from these tips, or at least use the tip to better formulate your own conviction about a trade. It is a good idea to look at the last tips the pundit made and how they turned out. When you do this and see the tipster got it wrong 70% of the time, it makes it much easier to resist their tips!
It is also a good idea to only watch financial TV in limited amounts.
4. Not Doing Your Homework
New traders are keen to get started and that is great. However, conducting thorough research and planning before entering any trades is the number one key to being a successful trader. As mentioned earlier, back testing is also crucial.
5. Not Seeing the Big Picture
When you are looking for a trade entry, you are probably zooming in. This is necessary, but the problem is that it can give you tunnel vision. While it is important not to get “paralysis by over-analysis”, it is vital to keep the bigger picture in mind. Is your trade in line with the long-term trend if there is one? Are you using an overly tight stop loss to enter a trade just before a major news release in the currency you are trading?
Be aligned with the few important things that are going on. You can do this in a few minutes at the start of the trading day by checking market news and calendars.
6. Overconfidence or Underestimating Your Abilities
For example, you see a trade set up that looks attractive. Just as you are about to enter the trade, your feel an inner doubt, and you cut down the size of your trade below the amount of risk your trading plan considers appropriate. Or even worse, you don’t take the trade. The trade becomes a huge winner, and you either miss out entirely or make only a fraction of the profit which you should have pocketed. You then get angry and either revenge trade, or risk too much on the next similar trade, which then turns out to be a loser.
Note how under-confidence can trigger over-confidence.
A big part of successful trading is having the courage to sit through the pain of losing trades. All traders lose money some of the time and there is no avoiding it.
7. Exiting Winning Trades Too Early
Believe it or not, this can become a major problem for traders who are succeeding in doing everything else right. This is because exits are almost always not optimal – repeatedly guessing the highs or lows of price movement precisely is impossible.
Let’s say you are in a trade which moves strongly into profit. It then stops going up, consolidates, and begins to reverse. You see the floating profit on your trading platform declining by the minute. You tell yourself that the likely outcome is that the price will go back to the entry point and if you follow a trailing stop exit strategy, you will end up breaking even or even losing. You exit the trade. It then turns around and becomes what would have been your biggest winner of the year.
8. Inexperienced Day Trading
The shorter the time frame you trade on, the better a trader you must be to be profitable. Bigger profits are potentially available on shorter time frames, because it is sometimes possible to use a short time frame to identify very precise trade entries which can generate enormous risk reward ratios. However, it is very important that as a beginner, you start your trading on higher time frames, because you don’t have to be as accurate. You could compare it to whether a newly qualified driver is safer driving a middle-range car or a very powerful sports car.
Don’t rush into day trading, prove yourself first as a swing trader.
The Bottom Line
Remember that once your account is down by more than 20%, you need to gain 25% just to get back to where you started, and the more you lose, the more that amount increases exponentially.
Nevertheless, provided you have an effective, proven strategy including proper money management and risk management and stick to it, you should be able to avoid problematic losses and make trading work for you.
What are the common mistakes traders make?
The most common mistakes traders make include not using a proven trading strategy, poor money management, revenge trading, and not using hard stop losses.
What should you not do in trading?
It is important not to trade on impulse, or to have unrealistic expectations. Research how your trading strategy of choice has performed in the past and try to understand why.
How do you overcome trade mistakes?
The most important thing to do is to take the time to analyze what went wrong and to find a way not to do it again. However, many traders find they need to make the same mistakes a few times before they can finally stop it.
When should you avoid trading?
You should not trade unless you have a valid trade entry setup according to the rules of whatever proven, back tested trading strategy you are using.