Trading mistakes are common and inevitable. As they say, a large part of “experience” is a result of learning from our mistakes. To be a successful and sustainable trader, it is not just important to analyse your performance, but also your feelings and behavior patterns. Psychology plays a pivotal role in the long-run. Since there are no entry barriers to becoming a trader. (All you would need is to open a trading and demat account with a stockbroker). You don’t need any minimum qualifications to be able to trade in the markets. Everyone needs to begin somewhere but there are some common trading mistakes which you must rise above.
10 common trading mistakes that you must avoid:
1. Never be too emotional about your views – Natural emotional instincts will dictate your trading behaviour if you don’t train yourself to become numb to them. Yes, it is important to become emotionally numb so that you are not affected if your views are wrong. By switching off your emotions, you can think rationally and reason with yourself. The tendency to hold on to your views with either frustration or hope is single-handedly the worst quality to possess. Most people lose money in the markets because they cannot accept that they went wrong. In my opinion, it is more important to spend time training yourself to be un-emotional than focusing on fundamental or technical analysis.
2. Never average a losing trade by taking on leverage - The most famous quote on this is by the legendary by Paul Tudor Jones who said, “Losers average losers.” The usual behaviour pattern among new/average traders is to increase the size of the position when the market is going against them. The intent is to reduce the average entry price by assuming extra risk in the hope that the stock turns around and they can exit at break-even point. The usual outcome of such actions is that the market goes against them some more and out of panic, they exit their positions at a larger loss than they initially thought.
3. Don’t be aggressive when losing and conservative when winning – Most traders who are act on emotional instincts, will become aggressive when they are losing their capital. They will trade ambitiously to break-even as soon as possible. Often, they try to earn back lost capital in a single trade. While they are making money, they become conservative and book profits too soon. If you want to be a successful trader, you will have to do just the opposite.
4. Never try to pick the peaks and troughs – Timing the markets is an essential activity but if you become obsessive about trying to buy at the absolute bottom and sell at the absolute high, then you’re in trouble. Instead of trying to time the exact pivot point, you must play the trend or range. It just makes more sense.
5. Never go against the trend – There is a saying, “No price is too low for the bears and no price is too high for the bulls.” Traders often think that their contrarian view is right and express this by trading against the trend. It is important to understand the dynamics of demand / supply before making this mistake. If there is demand for something, it is likely to continue and it is easier to make money off that trade than trying to figure out when the trend Is going to reverse. Likewise, if there is excessive supply (sellers), then the situation is likely to persist for some time and hence it makes sense to become a seller. Fighting a trend is certainly not easy or cheap. Trading against a strong trend is very dangerous and if you’re wrong, then the losses can be sharp. Instead, it is much easier to trade along with the trend. Now this doesn’t mean that you buy only breakouts and sell when there is a correction. There are different strategies to trade a trend but it is important to be bullish in a bull market and bearish in a bear market. You cannot have the opposite view and expect to make money.
6. Don’t expect the market to be rational – John Maynard Keynes said, ”Markets can remain irrational longer than you can remain solvent.”. Another famous quote from him was “There is nothing so disastrous as a rational investment policy in an irrational world.” The takeaway from this is that as a trader, it is best to give the market the benefit of the doubt and listen to what it is saying rather than trying to impose rationality. At the end of the day, it is the actions of a large group of independent buyers and sellers that is moving the markets. Markets are an information discounting mechanism and events which are likely to happen in the future are priced into the stock well in advance. If the expectation of the future changes, then the effect on the stock price will happen immediately and not in the future.
7. Don’t enter a trade without a plan – While entering a trade, make sure that you know your stop loss, time-frame and exit point. This clarity will help you scale in and out of a trade without aimlessly looking for external confirmation from news anchors or tips providers.
8. Do not buy illiquid OTM options – Traders often fail to recognize that apart from volatility risks there are other factors which seriously influence the price of the options. Time decay, liquidity, delta etc. are factors which need to be considered before entering a trade. Illiquid options generally have higher premiums and since they don’t have liquidity, the price deteriorates very quickly.
9. Don’t overestimate a winning streak or beginner’s luck – A streak of good trades can make traders feel like they’re invincible. When this feeling sets in, these traders take riskier trades without factoring in the possibility of trades going wrong. There are innumerable examples of traders who have gone down this way. It is important to recognize a winning streak or losing streak and act in a calculative manner.
10. Don’t overtrade – It can blur your plans and execution. When you feel like you’re overtrading, it’s best to take a break and go away. It is important to observe your own behaviour and know when to take a step back. It’s important to understand that the markets are always ripe with opportunities and taking a break doesn’t deprive you of them.
At Fyers, we’re always trying to add value to our clients and the trading / investing community in general. We hope you find this post useful. If you have any queries or doubts, feel free to ask me in the comments section below.