The 3 Most Common Mistakes in Trading
1. Trading without a Plan
Successful, experienced traders have a well-defined strategy, and they know when they should enter and exit trades. They also have plans about how much they're willing to risk.
Trading without a plan is one of the biggest mistakes made by new traders. It can put you at risk of making decisions based on emotions and behaving impulsively, which often leads to losses. Putting in the time to research and develop a trading plan, with a preset entry or exit strategy that takes into consideration your risk tolerance and market preference, enables you to remain disciplined and make decisions based on logic.
New traders are keen to get started and that is great. However, conducting thorough research and planning before entering any trades is the key to being a successful trader.
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2. 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.
Back testing can be very tedious, but if you are using a strategy that has not previously been profitable, why would you suddenly expect it to be profitable now? To improve your chance at success, back test your strategy over hundreds of trades, years into the past.
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.
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.
Using stop loss orders means you are taking steps to limit your risk, and to cut your losses.
Other Common Trading Mistakes
Here are some other trading mistakes to avoid:
4. Letting Losers Run/Averaging Down
Some people think that losing trades are avoidable. This is completely wrong – all serious traders take losses, and they can happen in any trade.
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.
5. Risking More than You Can Afford and Over-Leveraging
It’s easy for new traders to get carried away and one of the most common mistakes they tend to make is risking too large a sum on a given trade, out of a desire to earn big wins, as fast as possible.
It is critical to only risk as much of your balance as you can afford, otherwise your entire account can be wiped out in a single move. Know what you can stand to lose, and trade with appropriate caps, of 1%-2% of your balance per trade. This way, even if you have a series of consecutive losses, your balance should be able to weather the storm.
Long-term success is built on discipline, patience, and proper risk management. This is most evident, when it comes to using leverage. A double-edged sword, it can accentuate your winning trades, if used carefully, but it can also expand your losses. It is important to remember that leverage isn’t free and using too much leverage can be incredibly risky. Keep in mind 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.
6. Belief in Tips and Fear of Missing Out (FOMO)
Experienced traders know what they're looking for and what to avoid. They have a plan and don’t need to look for tips.
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.
If taken with a measure of caution, tips from pundits on TV and social media can help you to better formulate your own opinion about a trade, but it’s 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.
The problem is that an expert tip can feel like a can’t-miss opportunity. Fear of missing out, or FOMO, is a very real phenomenon and a trap that has caused many new traders to dive in to trades that do not suit their trading plan or involve assets they know little about. This can lead to under preparedness and overtrading, which can, in turn, result in losses.
FOMO has led many new traders to enter close to the top of a move and then when the trade turns against them, they have then had to exit near the bottom.
The great thing about the financial markets is that there are always new opportunities around the corner so if you miss out on one trade, there will always be another, that better fits your trading strategy.
7. 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 analyse 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.
8. 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.
9. Overconfidence and Self-doubt
The danger of overconfidence speaks for itself. Of course, we have all seen “beginner’s luck”, but sooner or later it runs out. However, what is less appreciated is the danger of self-doubt.
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 self-doubt 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.
10. 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 never 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.
The only way for most people to cope with this problem of exiting trades is to follow some type of trailing stop strategy. Trailing stops mean you always give up some of the maximal profit you could have made, but overall, it is highly unlikely you will devise a better exit strategy than a trailing stop or time-based exit.
11. Inexperienced Day Trading with Unrealistic Expectations
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.
The problem is however that many new traders have unrealistic profit expectations, expecting huge returns, within a single day, but this takes time, study, and practice. Expectations that are sky high can lead to serious mistakes like overtrading, and risky behaviours, out of a desire to reach unrealistic profit goals.
New traders are best served by setting achievable targets of around 4% returns a month. As you gain experience, your profit goals can change accordingly, but this will require patience, a willingness to build your skillset over time, holding off on day trading until you have the necessary precision, and setting reasonable expectations early on to assure long-term success.
Don’t rush into day trading, prove yourself first as a swing trader.
The Bottom Line
Provided you have the means and know what mistakes to avoid; trading can be profitable even for beginners. However, given that trading is highly emotive, it's easy to fall into traps that can lead to losses.
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.
FAQs
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 analyse 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.
Why do 90% of day traders fail?
The primary reasons why 90% of day traders fail is that they are lacking a trading plan, the discipline to hold to their strategy and a strict risk management plan.
What should you not do in day trading?
When day trading you should not allow emotion to rule your trading decisions and you should not trade without implementing predetermined exit and entry points.