Avoiding some of the common pitfalls of trading could save you a lot of money in the long run and help maximise your trading profits.
It’s all too easy to make these basic trading mistakes. So, what are they, and how best to avert such mishaps?
Not taking trading seriously
It’s good to see trading as enjoyable but you also need to take it seriously. That means investing some time and energy into understanding trading and laying the right foundations rather than rushing in without doing the necessary research and preparation.
Take your time, and make sure you fully understand what you are doing before you place real money on big trades. If you take time to lay the right foundations, you’re more likely to make a success of trading.
That way, you’re more likely to enjoy being a trader in the long run.
Allowing losses to snowball
A typical pitfall for those who are new to trading is to let losses from a trade that goes wrong get out of hand. A beginner can easily fall into this trap when they keep holding on to a losing position in the hope that the losses will reverse. Rather than reverse, the losses may just get worse.
This underlies the importance of applying discipline and consistency to trading, which comes with having a credible overall trading plan and strategy.
There are several identified trading biases that can contribute to greater losses than necessary. Learn about biases (https://capital.com/top-50-cognitive-biases-list).
Trading without a stop loss in place
It seems so obvious, but most traders have probably done this at some point, even unintentionally, perhaps because they have forgotten to set a stop loss, or possibly because they are new to trading.
Putting on a stop loss should be as easy as hitting an icon with a stop-loss tag on your screen. If you’re not sure how to put one on, you should definitely make sure you learn, at least before you start trading for real money.
Implementing a stop loss means you are effectively drawing a line in the sand on the potential losses from any given trade.
Failing to adequately control your losses from trading means that you could see all your profits or even your entire trading account value wiped out by just a few trades that go wrong.
With stop losses in place, we gain peace of mind, but also the ability to implement an effective trading strategy that could be highly profitable over the long term.
Stop-loss orders play a vital role in a trading strategy: to be profitable you need to make sure that either a higher proportion of your trades are winners than losers, or that your profit target on each trade is higher than your potential loss.
In an ideal world, you could manage to achieve both these latter aims. Never be tempted to move your stop loss when a trade doesn’t go your way.
Learn more about stop losses (https://capital.com/understanding-the-importance-of-stop-loss-orders).
No trading plan
Having a trading plan in place should impose discipline on your trading and avoid spur-of-the-moment decisions that you quickly come to sorely regret.
The plan should answer the why, when and how of trading, allowing you to define which trades you should take on, as well as the level of your stop loss and profit target for each trade.
If a trade doesn’t meet the criteria of your trading strategy, then you should not take it on.
Over the longer term, trading decisions taken in the heat of the moment that don’t meet your own pre-specified rules are likely to significantly detract from your trading profits.
Without a proper plan in place and having the discipline to stick to it, behavioural biases can take over, creating damaging trading errors where we end up making important decisions based on feeling rather than fact.
Not knowing your markets
Make sure you know the markets you’re going to trade well and that they suit your trading strategy. For instance, some markets may be more suited to very short-term trading strategies than others.
As a general rule, markets with narrow spreads (the difference between the buy and sell price), where there’s deep liquidity and lots of participants, should be more suited to very short-term, intraday trading strategies.
While you should understand the technical trading signals of the markets you trade, it’s also important to understand the fundamental drivers as well.
Fundamental drivers include the likes of company reports, central bank policy or any other sort of news flow.
Technical signals refer to those gleaned from charts, involving the price movements and trading volumes of the asset.
You will also find that some markets are highly correlated with each other. For instance, the UK’s FTSE 100 is more likely than not to be going up when the US Dow Jones index is moving in that same direction. In contrast, gold tends to be negatively correlated to such risk markets.
Having two open positions, in the same direction, on two sets of stock market indices, effectively doubles your risk.
Know your platform
Make sure you know how to use your trading platform properly. For instance, do you know how to set your take profit orders and stop losses correctly?
You should spend some time getting to know the features of your platform and how to use at least some of the technical trading tools that are available.
Effortlessly using and fully understanding your trading platform can remove unnecessary stress from trading and help you effectively implement your trading strategy and plan.
Lack of practice
Practice makes perfect, so the saying goes. Most trading platforms enable you to trade in simulation mode rather than using real money. It would be wise to give your strategy a try in simulation mode before you put real money on the line.
Simulation could also enable you to test modifications to your existing strategy. It could also allow you to test the waters in markets where you’re less experienced.
Don’t bet the farm
If you’ve tried simulation and you’re comfortable with your chosen market, trading strategy, plan and platform, you should be pretty much ready to go. However, you need to make sure you’re also happy with the level of risk you’re taking.
Stop losses are essential to help you control risk, but it could also be worth starting out by risking smaller sums of money rather than bigger bucks. Always make sure you’re comfortable with the level of potential loss from a trade.
Losses are part and parcel of trading. You need to understand that and limit your potential losses to an amount that you will feel comfortable accepting.
Not learning from your mistakes
While we should all want to avoid making mistakes, if we do make them, let’s learn from them. Documenting the details of each trade so you can later go back to review the actions and outcomes involved can ultimately help you improve your trading strategy.
Such regular reviews can also be used to verify that you are indeed keeping to your own trading plan.
Whether you’re just beginning to learn to trade, or whether you’re someone who’s been trading for many years, there’s always something that can be improved.
- Identify how much you are prepared to lose
- Research and identify suitable markets for trading
- Set a trading strategy to avoid falling foul of psychological trading biases
- Use stop loss and take profits orders
- Keep records and adapt your trading strategy to avoid repeated mistakes