In everyday life, bad habits can have any number of side effects. Weight gain, illness or social exclusion, for example. Bad trading habits, by contrast, affect people in just one way. They lose money.
This is particularly the case in the market for contracts for difference (CFDs). Because CFDs are essentially a trading instrument, rather than an investment medium, getting the trading right is absolutely the key to a successful strategy.
There are a number of bad habits, but perhaps above all of them is the overarching bad habit of failing to recognise that such habits exist. Identifying bad habits is the essential first step toward breaking them.
The first group of bad habits can be considered under the heading of trading for what are essentially emotional reasons. This would obviously include trading a stock or any other security because of an irrational attachment to a particular company, currency or commodity.
Recognising a bad trade and bailing out
But this category includes also such fallacious behaviour as hanging on to a bad trade for too long on the basis that it “owes you”, thus will come good eventually.
It doesn’t owe you anything and the chances are that it won’t.
This leads to our second category, the failure or reluctance to recognise that a trade has not worked out. Along with “buy low, sell high”, the injunction to “run profits and cut losses” is a well-worn catchphrase. But it is valid nonetheless, and the reverse, of course – running losses while taking profits – is a sure route to failure.
As a sub-set of this second category, taking profits too soon can be as damaging as cutting losses too late. Provided you have the right strategy in place, you can be patient and let profits accumulate, in the knowledge that you will be out of the trade at the first sign that it will turn downwards.
A third category could be described as trading for the sake of trading. This includes making a trade to break the tedium of a quiet period in the market, or trading excessively in the belief that frenetic activity increases the chances of a big win. It doesn’t.
A plan is the key
As with successful military strategy, pick your battles – or, in this case, your trades – carefully.
We have already mentioned, in passing, the need for a trading strategy, also known as a trading plan.
Such a plan will include the level of risk you are prepared to take and will define what you want to achieve and what will count as success. A critical part of the plan will be self-imposed rules for cutting losses, in terms of the percentage loss at which you will bail out of the trade.
Perhaps equally important are self-imposed rules for taking profits. This does not contradict the earlier injunction against cashing in a profitable trade too soon. Because, as we have seen, the plan defines what counts as success, the time to take profits is when a pre-set profit target has been reached.
It was the late Swiss-American investment guru Max Gunther who described hanging on to such a market position after success has been achieved as being as irrational as a runner, having breasted the tape at the finish line and winning the race, setting off round the track once again.
It is a useful image to bear in mind.
Failure to draw up a proper trading plan can be considered our fourth bad habit. It leads on to our fifth such bad habit, which is to construct what can only be described as a dud trading strategy.
This can take many forms. It could be one based on the notion that most market traders are mostly wrong most of the time, thus success will be guaranteed if you bet against the current trend, either up or down.
Unless you are either very lucky or hugely experienced, the chances are that you will end up in the company of the “mostly wrong” traders.
Check and double check
Another strategy likely to end in tears would be one based on deeply unreliable indicators of likely market moves. Over the years, these “alternative signals” have included the winner of America’s Super Bowl football tournament and the market reaction in the second year of a Republican in the White House - it was supposed to be consistently negative.
Their likely effect on your trades will indeed be “alternative” – to making money.
A sixth bad habit follows on from this, which is the timeless belief that trading is essentially a get-rich-quick scheme and that a big payoff is practically guaranteed. It ought not to be necessary to mention the absurdity of this view. Sad to say, it is.
This leads to our seventh and final bad trading habit – failure to conduct proper research. A successful trading strategy will be underpinned by thorough homework into the proposed positions. This must amount to more than running the name of a company or commodity through an internet search engine and skimming the first two or three results.
It must involve checking and double-checking all the assumptions underlying the strategy and the specific trades that you are considering.
Bad habits lead to failure. Their reverse, good habits, can be seen as success habits, the habits of the wealthy.
All these bad habits can be considered as different aspects of one “master habit”, a failure to respect the market and to prepare properly before trading. To end where we began, the first step to curing yourself of these habits is to be aware of what they are and be able to identify them.
And to make your trading experience smoother, watch our video on 5 most common trading mistakes with David Jones: