"In truth, most professional Wall Street traders have made many trading mistakes, according to trading experts. The key to their eventual success, however, is that the professionals study their mistakes and learn how to minimize them going forward. "It’s all right to make mistakes," admits Dr. Alexander Elder, psychiatrist and author of Come Into My Trading Room. He adds, "If you aren’t making mistakes, you aren’t learning. But it’s absolutely unacceptable to repeat those mistakes."
This Fidelity list may look a bit familiar — see The Zen of Trading for an earlier version of these rules — but it is valuable nonetheless. I’ve edited down what was originally a (near advert) into something less marketing orineted and hopefully more useful: The 10 of the most common mistakes made by active stock traders:
1. Little Preparation or Training
When you enter the market arena, you had better be prepared. However, few traders perform the necessary due diligence before moving headlong into the markets: "The market is a food chain — the big fish eat the little fish."
Dr. Elder agrees that many people underestimate what it takes to be a profitable trader.
Recommendation: Enter the market with a sufficient amount of training, through vehicles such as books published on securities trading, educational courses, and trading conferences.
2. Being Too Emotional About Money
According to professionals, the reason many emerging traders fail to consistently earn profits is because of their perceptions of money.
There are ways to desensitize one’s emotional connection to money. Start by trading smaller share size (such as 100 shares per trade). Trading in smaller quantities can help minimize both the losses and the emotional distress that often comes with losing larger amounts of capital.
Recommendation: Over time, as a trader becomes more successful, experts suggest slowly
raising the share size — without raising your blood pressure — until a
personal comfort zone is reached.
3. Lack of Recordkeeping
It’s understandable why traders become emotional when trading stocks. To help bring these emotions under your control, keep a detailed trading diary.
4. Anticipating Profits
Most traders don’t want to acknowledge that a trade could turn against them. They enter the market assuming they’ll be successful, refusing to look in the rearview mirror. It’s also common for emerging traders to use a calculator to predict how much they’ll make and how they’ll spend the unrealized profits! It’s dangerous to anticipate how much you’ll make in advance.
Recommendation: Enter a trade with the understanding that you may not be right. It can then be easier to acknowledge if a trade goes against you.
5. Blindly Following Mechanical Systems
A large percentage of traders use technology — in the form of online trading platforms that provide charting, research, and backtesting tools — to help them refine their strategies. A computer and software can provide important information about the technical and fundamental characteristics about stocks. However, many traders make the common mistake of relying too much on these tools without a full understanding of their capabilities.
Recommendation: Understand that computers and software trading platforms are only tools. Learn how to grasp the underlying trading concepts — such as reading and analyzing a chart —and know the reasons why you bought and sold a security.
6. Not Learning How to Short
If you fail to learn how to utilize short trading strategies, then you have cut yourself out of a number of profitable trades. Many people think that shorting is un-American or too risky.
By not learning know how to go short, you’re removing a significnat percentage of potential trades, especially when the Bull market falters. The market is a two-way street, and the person who doesn’t short is missing a part of the game.
Recommendation: Don’t underestimate the importance of shorting stocks, and learn how to utilize this technique.
7. Lack of Specialization
Many people are attracted to trading because they think it’s an easy vehicle for making money. However, there are several types of securities that can be traded in today’s markets, including stocks, options, commodities, futures, and currencies. It is a daunting task to learn the characteristics of each security type. Therefore, it’s often helpful to specialize.
Recommendation: Know what you trade. Don’t spread yourself too thin by trading markets that you don’t understand.
8. Improper Timing
It’s very common for emerging traders to make timing mistakes. Quite often, a trader may have a good idea, but discovers that he or she bought the stock at an inopportune price. Timing a trade is never an exact science, but it’s important for traders to recognize that there are times when it might be prudent to lock in a profit or cut a loss.
Recommendation: A detailed trading diary and experience could help minimize timing errors.
9. Placing Improper Stops
Many traders incorrectly place stop orders, causing their positions to get stopped out too early and failing to capture much profit. It’s common for newbies to place stops according to a set percentage, such as 2%, or a set amount. How much a trader is willing to lose depends on his or her risk-tolerance.
Place stops according to what the market is telling you, such as support and resistance levels. When placing a stop, let the stock’s behavior, or a standard deviation, tell you where the best stop placements are.
Recommendation: Try placing stops according to the stock’s standard deviation, rather than on the basis of percentages or dollar amounts.
10. Not Calculating a Stock’s Risk-Reward Ratio
Many traders do not calculate the risk-reward ratio of a stock trade before they establish a position. A stock’s risk-reward ratio is the relationship between an investor’s desire for capital preservation at one end of the scale and a desire to maximize returns at the other end.
How do you determine a stock’s risk-reward profile? There are three common components of a stock’s risk-reward ratio: current stock price (a known); and a profit objective and stop exit price (both subjective). Calculating a profit objective and a stop exit for a trade often involves many factors, such as standard deviation or technical indicators, including Fibonnaci and moving averages.
Recommendation: Before you enter a trade, the first question you should ask yourself is: What is the risk-reward ratio of trading this stock? If you are a novice trader, using a low risk-reward ratio could help lower your potential downside.
Entering the market with a neutral attitude is a good approach.
"What is, is. If you’re in an uptrend, go long. If you’re in a
downtrend, go short. If you’re overbought, wait for a reversal and go
short. If you are oversold, wait for a reversal and go long."
-Robert Deel, CEO and trading strategist for Tradingschool.com
10 Common Trading Errors