The mechanics of trading are relatively simple. 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 seven common mistakes that traders—both new and experienced—sometimes make.
Mistake 1: Emotional trading/psychological trading
Trading can bring out the best and the worst in us. For a trader, 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 quickly 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 often make the mistake of trying to jump on a move after it's already happened—often at the point when it's ready to reverse.
The reality is that markets are cyclical, moving through ups and downs. Trading decisions based on emotions may not always give the results you want. Instead, take a step back and think through the situation logically. Every situation is different, and instead of buying or selling in a panic, think about how you can best manage risk.
Mistake 2: Pulling stop orders
When a position hits a stop order, it can often mean you're going to take a loss on it. Pulling—or canceling—a stop is often a subliminal 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 and be profitable.
The problem is every 50% loss starts with a 5% loss. It's not magic; it's just math. And it only takes one small loss that turns into a big one to make a big dent in a portfolio. Losing is no fun, but it's part of trading. Being disciplined about managing stop orders may help you come back and trade another day.
Mistake 3: Playing earnings
Many experienced traders say a secret to their success is trading only when they have an edge—real or perceived. An edge can be a viewpoint, such as something in the charts or in the fundamentals that says, "the scales look to be tipped one way on this." And if a trader doesn't see that edge in a trade, it's one to avoid.
Earnings can sometimes fall into that category. Sometimes, no matter what your indicators or charts say, or how well you think you've analyzed a company's fundamentals, a stock's reaction after an earnings announcement is still basically a coin toss because of all the subjectivity involved. It may be best to avoid trading around earnings.
Mistake 4: Trading the wrong time frame
Every trader has an internal image of what type of trader they think they are. Sometimes that image is correct, but sometimes it's not. You may imagine yourself to be a fast-paced day trader, but in truth, maybe your personality is better suited for swing trading, where you hold positions for time frames of two to six days or longer. Or maybe you've been swing trading and you'd like to pick up the pace.
Trading in the time frame that best fits your personality allows you to be more comfortable and relaxed, which can promote clearer thinking and better decision-making.
Mistake 5: Technical indicator creep
Traders may use technical indicators to trigger entries and exits to make their decisions more objective. For example, if a stock breaks below a technical level such as a five-period exponential moving average (5EMA), there's no way to deny it; it is what it is. But sometimes technical indicators can be used to rationalize otherwise irrational trading decisions.
Suppose you decide to sell a stock when it breaks below the 5EMA, and it does. But maybe you're hesitant; maybe you change your indicator to a 9EMA. And if that's broken, a 21EMA, then a 50EMA, and so on. You keep giving the stock more room, more chances to avoid taking a loss, using different technical indicators or values to justify your actions.
Mistake 6: Trying to pick tops or bottoms
There's a fascination among traders about picking turns. 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.
Mistake 7: Avoiding decisions while trading
Notice a shared theme among several of the mistakes on this list? It's "avoiding decisions."
Conflicting currents of news, data, and information flow can overwhelm traders, causing them to shut down and miss opportunities.
Heard of "analysis paralysis?" When you're holding a position, analyzing too many variables can cause you to freeze. It may be better to take the initiative and decide, one way or the other, even if you're not 100% certain of the right answer. Because refusing to act won't stop the markets.
This material is intended for informational purposes only and should not be considered a personalized recommendation or investment advice. Investors should review investment strategies for their own particular situations before making any investment decisions.
Investing involves risk including loss of principal. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
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.
A trailing stop or stop order will not guarantee an execution at or near the activation price. Once activated, they compete with other incoming market orders.
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.1122-23BG