5 common trading mistakes and how to avoid them
To make trading mistakes is unavoidable, but most of them can be avoided if a trader learn from both successful and unsuccessful positions.
These are 5 of the most common trading mistakes and how to avoid them:
Neglect to research the markets properly
Some traders tend to open or close a position on a gut feeling, or because they react on a tip. Although this may yield results, rather back such feelings or tips up with evidence and market research before opening or closing a position.
It is crucial that you understand the market you are entering before you open a position. Some of the things you should research before committing to a position include whether it is an over-the-counter market or on exchange; and if there is a large degree of volatility in a particular market or whether it is more stable.
Trading without a plan
After a bad day on the markets, traders are often tempted to scrap their plan. This is wrong, because a trading plan should be the foundation for any new position. A bad trading day doesn’t mean that a plan is flawed, but simply that the markets weren’t moving in the anticipated direction during that period.
Trading plans should act as a blueprint and contain a strategy, time commitments and the amount of capital that you are willing to invest. It is wise to keep a trading diary that contains your successful and unsuccessful trades and the reasons why, so that it can help you learn from mistakes and lead to more informed decisions in the future.
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Over-reliance on software
Although trading software like MetaTrader 4 offer full automation and customisation to suit individual needs, it is important to understand the pros and cons of software-based systems before using them to open or close a position. Algorithmic trading can carry out transactions much faster than manual systems and has revolutionised the way we interact with the markets, but it still lacks the advantage of human judgment. These systems may have been responsible for causing market flash crashes in the past, due to the rapid selling of shares or other assets in a temporarily declining market.
Lack of understanding of leverage
Leverage is essentially a loan from a provider to open a position, thus it can increase gains, but can also amplify losses.
While trading with leverage is an attractive prospect, it is important to fully understand the implications of leveraged trading before opening a position. Traders with a limited knowledge of leverage may soon find that their losses have wiped out the entire value of their trading account.
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Failing to cut losses in the hope that the market turns
Traders are often tempted to let losing trades run hoping that the market turns. This can be a costly error that can wipe out any profits a person may have made elsewhere.
There is no point in trying to ride out temporary slumps in the market, as all active positions must be closed by the end of that trading day.
Stops can close a position that is moving against the market at a predetermined level to minimise your risk by cutting your losses for you.
Overexposing a position or overdiversifying a portfolio too quickly
A trader can overexpose himself if he commits too much capital to a particular market. This usually happens if a trader believes that the market will continue to rise, but while increased exposure might lead to larger profits, it also increases that position’s inherent risk.
Diversifying a trading portfolio can act as a hedge in case one asset’s value declines, but it can be unwise to open too many positions in too short a time. The potential for returns might be higher, but having a diverse portfolio requires a lot more work which may not be worth the reward, particularly if you don’t have much time.
