Last Updated on May 10, 2024
Trading can be a profitable endeavor, but it comes with its own risks. Inexperienced investors often make trading mistakes that can cost them a lot of their hard-earned money, such as lack of planning, emotional trading, overtrading, poor risk management, and so on.
To help you become a better trader, in this article, we will discuss the most common trading mistakes and how to avoid them.
Lack of Trading Strategy or Plan
One of the most common trading mistakes that traders make is having a poor trading strategy. Even worse, some traders don’t have a trading plan at all. Entering into trades without a clear idea of what you want to achieve can easily lead to confusion and poor decision-making. As such, the most likely outcome is losing money.
Therefore, having a well-established trading strategy or plan plays a central role in achieving trading success. A trading plan serves to pinpoint the trader’s goals, the markets they will trade, the timeframes they will trade on, and the risk management strategies they will use. In addition, it helps them determine their precise entry and exit points, the amount of cash they are willing to invest, as well as the maximum loss they are ready to incur.
Some traders are tempted to ditch their strategies after a couple of bad trades. This is another one of those trading mistakes that newbies tend to make.
A robust trading plan is the engine of any market move. Having one or several bad days doesn’t directly signal the strategy is poor. Many other factors might be at play. For example, it might indicate that the markets aren’t moving in the expected direction during a particular period.
That is why sticking to the trading plan through thick and thin can often be your best move (assuming you have a sound strategy, of course).
How to Avoid it
There is only one way to avoid this trading mistake: taking the time needed to come up with a solid and well-tested trading strategy before entering the market. When developing it, traders should consider several key things, including their goals, risk tolerance, tradable markets, and more.
Furthermore, a trading plan should also include a set of rules that the trader will follow to execute trades and manage risk (e.g., entry/exit points).
Once the trading plan is in place, traders should review it regularly and make tweaks if necessary. This will ensure that the trading plan remains relevant and effective.
Lack of a Proper Risk Management Strategy
Another common trading mistake that traders make is not having a proper risk management strategy in place. Trading is fundamentally a risky practice, and having a proper risk management plan is just as important as having a trading plan.
A risk management strategy primarily serves to help traders reduce potential losses, including losing all of their account balance at once (e.g., when trading on leverage).
A sound risk management strategy should include using stop-loss and take-profit orders, as well as position sizing, among other things. For example, while trading without stop-loss can sometimes work out, it is simply unnecessary, and in most cases, it ends up in significant losses.
Another widely used risk management technique is the so-called one-percent rule. It suggests that traders should never allocate more than 1% of their capital into a single trade. For example, if you have $5,000 in your trading account, the one percent implies that you shouldn’t place more than $50 on a single trade.
How to Avoid it
To avoid losses, traders should have a clear understanding of their risk tolerance and set risk limits that they won’t exceed.
Stop-loss orders, position sizing, the one-percent rule, and portfolio diversification are all reliable risk management techniques that have been around for decades.
Like with trading strategy design, new traders should also spend sufficient time developing a risk management plan and researching the most useful methods before entering the market. Doing this helps minimize losses and protects the capital.
Remember, it is much easier to lose money than earn it, and trading without a decent risk-management strategy can substantially increase the chance of a loss.
Emotional Trading and Lack of Discipline
Emotional trading is quite common among novice traders. That is why learning to control emotions is one of the first lessons a beginner should focus on.
Note that trading can bring out both the best and worst emotions in traders. Unfortunately, the latter is more prevalent with inexperienced traders. They often get incredibly frustrated when the market doesn’t move in their preferred direction or when they miss out on a trade they have been considering making. As a result, they struggle to make rational decisions.
Emotional trading surfaces the risk of wiping out one’s account balance in a matter of just a few trades. That’s why working on controlling your emotions when you are in the market is vital to becoming successful.
Similarly, lacking discipline in trading can also lead to poor decision-making. Indisciplined traders are likelier to deviate from their trading plan or take on trades that don’t correspond with their risk tolerance. Being disciplined often equals being profitable, and the best way to ensure that is by sticking to your trading plan.
How to Avoid Emotional Trading
To avoid emotional trading, traders should develop a mindset that is focused on their long-term trading goals. This mindset means learning to control emotions and avoid making impulsive decisions based on fear, greed, or anger.
It is also very important to acknowledge that markets are cyclical, meaning they consistently move through ups and downs.
Making decisions based on current emotions is less likely to produce the desired results. Instead, it is often better to take a step back and analyze why things aren’t going your way. Each time you enter, the market will be different. Rather than buying or selling in a panic, take some time to think about how to improve your trading and risk management strategies based on the dominating market conditions.
Overtrading
Overtrading is when traders excessively buy and sell securities. This usually occurs after individual traders have sustained a single major or several smaller losses. Similar to emotional trading, this makes them panic. As a result, they engage in the so-called “revenge trading”, where they try hard to recover from their losses by trading at scale.
Most commonly, traders do this by increasing their position sizing, and executing more trades.
Overtrading usually leads to poor performance. It can also cause fatigue and burnout, which can negatively impact a trader’s efficiency.
How to Avoid Overtrading
The most important step to avoiding overtrading is to realize that you are the only one responsible for it. As a result, you are the only one who can prevent it.
An efficient method to avoid overtrading is developing a trading plan (learn how here) that sets in stone the number of trades you will make per day or week. Predetermining trading goals and limiting the trades only to those meeting the goals is another useful strategy.
To prevent overtrading and enhance their overall performance, many market participants focus on avoiding trading during periods of high volatility and focusing only on high-quality market opportunities.
For more information, check out our dedicated guide that explores which are the first signs that you should stop trading.
Trading the Noise
Trading the noise refers to making trades based on short-term fluctuations in the market that aren’t indicative of the long-term trend.
These fluctuations can often be caused by incomplete or inaccurate info, news, or other short-lived market events. Trading the noise is usually an irrational move associated with significant risk. Since most trades are based on rumors and hype, they aren’t backed by proper technical or fundamental analysis, thus, have a higher chance of losing you money.
It is worth noting that when there are too many noise traders, they can often significantly impact the market. In other words, they can cause an artificial reaction to their trades, sending stock prices sharply in either direction, even though all other traders are making rational moves.
Noise trading is typically tied to high-volume trading days. During these periods, noise traders usually overinflate security prices during bear runs and push them down excessively during bear runs.
Ending up trading the noise is usually motivated by FOMO or other bias, always going against your trading plan. As a result, it is hardly clear what outcome you can expect from a particular trade.
How to Avoid Trading the Noise
Following your trading plan is the most critical step to avoid trading the noise.
Always stick to using technical and fundamental analysis and perform in-depth research instead of trading the news. This helps identify the long-term trend of the market and pinpoint high-quality trades rather than chasing short-term fluctuations.
Using multi-timeframe analysis (analyzing multiple charts before making a decision) is another helpful way to filter out the market noise.
Conclusion
While trading can be very lucrative, it also comes with substantial risks. Most of them are easily avoidable since they are a byproduct of the most common trading mistakes, such as not having a trading plan, lack of proper risk management, making trades based on emotions, and overtrading, among others.
Avoiding these trading mistakes can help traders significantly minimize losses and maximize gains in the long term. If you want to learn more about the most common mistakes that technical analysts make, feel free to check out our dedicated article.
