The mechanics of trading are relatively straightforward: A click or two gets you into a trade, and a click or two gets you out. But the decision-making process behind those clicks is much more complex. And with complexity comes more opportunities to make mistakes that can affect your bottom line. Here are five common mistakes that traders—both new and experienced—sometimes make.
Mistake 1: Emotional trading
Nothing is more frustrating than opening a long stock position and seeing the market drop, bringing the value of your long position to levels well below the price you bought it. The same can be said about missing out on a move in a stock that's been on your radar for a while.
Anger, fear, and anxiety can lead traders to make quick and even irrational, emotion-based decisions. For example, if a long position starts losing money, traders may start buying more positions at lower prices or opening short positions on the same stock, thinking it's a way to get even with the market.
And when it comes to missing out on a move, traders might make the mistake of trying to jump on a move after it's already happened—perhaps at the point when it's ready to reverse.
The reality is that markets are cyclical, moving through ups and downs. Instead of buying or selling in a panic, think about how you can best manage risk.
Mistake 2: Moving the goal posts
There are many ways to avoid admitting you've made a mistake, but it's generally better to acknowledge a small loss than to keep digging in and lose more.
Say you've set a stop order on a position so if it falls below that price, you'll automatically sell. Pulling—or canceling—a stop is often an unconscious attempt to avoid admitting you were wrong. After all, as long as the position is open, there's still a chance it could come back. (Of course, it could also fall a lot further.)
Or imagine you generally rely on a short-term technical indicator, like a five-period exponential moving average (5EMA), to determine when you should sell a stock. If a stock breaks below the 5EMA and you change your indicator to a 9EMA, then a 21EMA, you're probably just using technical indicators to rationalize an otherwise irrational trading decision.
It's usually best to stick to the plan you had, using the indicators you typically rely on, and take small losses quickly rather than dragging out a losing trade.
Mistake 3: Playing earnings
During earnings season, you might find yourself with a firm conviction about which way a stock will move—maybe your preferred indicator points a certain way or you feel you know everything there is to know about a company's fundamentals—but that doesn't mean you're right. And markets can surprise you. So, it may be best to avoid trading around earnings.
Mistake 4: Trading the wrong time frame
Maybe the fast pace of day trading makes you anxious, or the slower pace of swing trading (where you hold positions for two to six days or longer) bores you. Either way, trading at a pace you don't enjoy probably won't lead to the best outcomes. Find the time frame that best fits your personality, and you might find you can think more clearly and make better decisions.
Mistake 5: Trying to pick tops or bottoms
Which story is more fun to tell: The one where you made money following a strong trend, or the one where you picked up a stock at a bargain low? If you're like many traders, you'd prefer the second one because it's a lot more dramatic.
Perhaps that's why some traders spend a disproportionate amount of time trying to buy bottoms or short tops. Of course, the problem with this approach should be self-evident. If you're more concerned about how you made money than actually making it, you might be trading for the wrong reasons.
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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
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Short selling is an advanced trading strategy involving potentially unlimited risks and must be done in a margin account. Margin trading increases your level of market risk. For more information please refer to your account agreement and the Margin Risk Disclosure Statement.
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There is no guarantee that execution of a stop order will be at or near the stop price.