What is overtrading?
In business, overtrading is when a company grows too quickly for its finances to support it, causing a loss of working capital and risking collapse.
In finance, overtrading is usually when a broker buys and sells excessive amounts of stock to try to generate more commission from an investor. But individual traders can be guilty of it too.
Undertrading, again in finance, is the opposite of overtrading, with investors missing opportunities ('leaving money on the table', as the expression has it) through excessive caution.
Where have you heard about overtrading and undertrading?
Overtrading is one of the top mistakes investors/businesses make and so you'll come across it in many financial advice articles and guidebooks. Undertrading receives comparatively less coverage, but sophisticated reports and books will draw attention to its dangers.
What you need to know about overtrading...
In finance, overtrading is also known as churning and it’s not only done by brokers trying to increase their commission, investors can also get carried away with excessive trading activity. However, to prevent your broker using this practice, invest in a wrap account as this charges a flat service fee rather than taking commission per transaction.
The best way for investors to avoid overtrading is to have a clear trading plan or strategy. Within this you can set a limit on the number of trades per day as well as profit and loss limits to minimise risk.
Such a plan is also recommended as a guard against undertrading, by acting as a prompt to trade when the plan says this should happen.