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.