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Biggest Mistake New Traders Make and How to Avoid Them

One of the deadliest mistakes a trader can make is to let his or her trading be dictated by emotion.

 

At one stage or another, most traders have lost the element of control after a trade has turned sour unexpectedly.

The reaction is usually to dive back into the next trade in an attempt to regain the loss in the shortest period of time, without pausing to reflect and re-evaluate. This is known as revenge trading and the consequences can be detrimental to the balance of your trading account and your mental health.

 

 

Occasional losses are part and parcel of the business of trading. A willingness to accept the maximum drawdown on your account instead of chasing your losses is pivotal to avoiding a revenge trade.

 

 

A losing trade can quickly be compounded into a series of losses should the trader be overcome with feelings of disappointment and rage, instead of taking a more pragmatic approach to trading. An innate need to be right has undone many traders, and this mindset is to be avoided at all costs if you want to keep your trading accounts in order.

 

 

Ed Seykota, a highly respected trader, and a mentor to several of the world’s most successful traders once said, “I handle losing streaks by trimming down my activity. I just wait it out. Trying to trade during a losing streak is emotionally devastating. Trying to play ‘catch up’ is lethal.”

 

Mindset is 70% of trading. The most successful traders are calm, focused and committed to their trading plans and strategies.

 

Aim to find your trading ‘happy place’. A relaxed outlook and mental clarity when decision-making is essential to detach the act of placing the trade from the emotions that are naturally associated with issues of a financial nature. Take peace in the knowledge that once you have entered a trade and your stop losses are in place according to your trading strategies, the movement of the markets is out of your hands.

 

Trading out of boredom or spontaneously is a recipe for a loss, as is trading for countless hours. If you don’t see a trade opportunity, then it is wise not to place a trade!

 

If you manage to detach your emotions from your trading, it is important to remember that the majority of investors on the market do act on how they feel.

 

Stick to Trading Rules

An old Wall St adage is that markets are motivated by greed and fear. Sometimes an irrational reaction from the ‘crowd’ to a news piece or an announcement can impact on stock prices, despite the full scope of data stating the opposite.

 

Forgetting the Importance of Sticking to your Rules

Not sticking to your trading rules is a guaranteed way of emptying your trading account.

 

 

Successful traders abide by a trade plan. This set of rules, the basics of which remain the same whether they plan to hold the stock for a short period or if it is a long term investment.

 

 

Your trading plan is best created before you start trading, so you have a clear set of rules for entering, and similarly, exiting a trade should certain market conditions arise.

 

 

Your trading plan needs to be detailed, so writing down rough outlines or musings like “I want to be a millionaire” will not suffice. You need tangible guidelines that you stick to regardless of outside influences, emotions or gut feelings.

 

If you set a realistic price target exit, you can set a trailing stop price and after the stock moves you can adjust it to at least break even. If the trade is losing, you need to have established a final exit price. Even the most savvy traders experience losing trades, there is no shame in enforcing a money management strategy that minimises your losses.

 

Sticking to your rules is important. History is littered with fallen traders who have ignored their cut off markers in anticipation of a rally, only to see the stock plunge further.

 

Similarly, traders that have risked too high a percentage of their accounts on trades tend to react too quickly to market movements because of the risk involved in the trade – so winning trades are cut short and losing trades that have potential to be winners are closed because the trader cannot swallow the prospect of having a significant portion of their bank exposed.

 

A trade plan that you can follow in good and bad times is the best way to achieve consistency and reduce emotional involvement.

 

No system will deliver 100% winning trades, so you need to be confident in your rules and let them run through the natural ebb and flow of winners and losers.

 

Trading is a long term game – the aim, is to stay in the game.

 

Set Trading Goals and Targets

 

Setting clear and concise goals is essential to achieving success in any field or endeavour, and trading is no different.

 

A costly mistake traders can make is to start investing without having a defined list of objectives to guide their decision making.

A 2008 report by the Australian Securities and Investment Commission (ASIC) based on the responses of more than 1200 Australian investors indicated that 37% did not have a goal or plan before taking action on their investment opportunities.

 

Without goals in place, your trading becomes a rudderless chain of exercises that bring you no closer to achieving your financial targets. Not having goals and objectives means you are more likely to break rules and jump into trades without due consideration.

 

Track Your Investment Performance

Furthermore, it is vital to keep track of the performance of your investments and review your plans/goals regularly. How do you know if you are performing if there are no goals in place?

 

Returning to ASIC’s report, it was noted that 32% of the sample group chose to review their investments and strategies annually, while 12% admitted that they NEVER took any notice of how their portfolio was performing. That’s nearly half of the representation of Australian investors that were out of touch with their money!

 

Reluctance to adhere to plans and goals and monitor your progress towards them is detrimental to your trading success. Take the time to sit down and evaluate your goals and objectives. Whether it be growing your assets, providing cash flow for your lifestyle, maintaining your purchasing power or building a diversified portfolio – everything will seem far more achievable if you set aside some quality preparation time to identify your goals and the course of action you need to take to realise them.

 

Having Too Much Risk

 

Carrying too much risk into a trade is a costly mistake committed all too often by traders hoping to make a big “score.” Investing a large percentage of your bank into any individual trade is risky behaviour that could fast track you on the road to financial ruin.

 

 

Managing how much money you commit to each trade is vital, as it governs how much you might profit or lose.

To be conservative, let’s review the downside. If you invest too much in a trade, then it only takes a few consecutive losing trades and a large part of your account might be gone. Once your funds are depleted, it takes many more winners to compensate for what you have already squandered.

 

A 5% loss on your account means you only need a 5.3% gain to come back, which is manageable, but if you blow 90% you need a staggering 900% gain on the remaining capital to recover.

 

Mr Larry Hite, one of the traders profiled in Jack Schwager’s Market Wizards, is considered one of the top 100 traders of the 20th century. Hite maintains that control and consistency in risk management is essential to successful trading and his strategy is comparatively conservative.

 

“Never risk more than 1% of your total equity in any one trade. By risking 1%, I am indifferent to any individual trade. Keeping your risk small and constant is absolutely critical.”                           

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