With the dawn of the new year, it is customary to talk about resolutions, irrespective of whether we follow it or not. Let’s talk about the typical mistakes a trader should avoid in order to protect capital. Once capital is protected, the trader will survive long enough to see their capital grow.
Here are the most common mistakes a trader needs to avoid. Please be reminded that by no means is this list exhaustive.
1. Trading without a plan: As in any endeavor, it becomes impossible to succeed in trading without a proper game plan. The plan should have answers to the following questions:
a) How many losing trades should one take in a row before taking a break?
b) What should be the maximum risk exposure in a single trade?
c) What is preferred time frame for trading – Positional / Intra-day
d) When and why should an intra-day trade be carried over to the next day?
The above set of questions is just a few basic ones that need to be addressed. Besides, you can also include other elements such as what is the basis for taking the trade, where is the entry, exit and stop-loss etc.
2. Rushing Into a Trade: Traders typically have this tendency to get impatient and rush in to a trade too early. Rather than awaiting confirmation, traders tend to get anxious about missing a potential move and end up taking a trade too early. This normally results in a poor trade location and by extension a compromise on the ideal stop-loss placement. Price always fluctuates and seldom run away uni-directionally. Hence, sit back and relax. Trading is akin to hunting. You should not blindly chase the prey. A sensible approach would be to lay a trap and wait for your pray to fall into it. This analogy holds good in trading too.
3. Trading without Stop-loss: While anyone who is initiated into trading would have heard and read enough about the importance of stop-loss. But, not too may take it seriously. Once the trade goes against you and gets beyond your normal pain threshold, the brain practically freezes and fails to react logically. That is the reason you lack the courage to cut your losses when it goes beyond a point. The trade then typically becomes a long-term investment. Hence, always enter the stop-loss the moment your trade gets executed.
4. Over-Trading: This is another typical mistake that traders commit. Traders have this mindset that trading frequently is a proxy for being active and successful. This is seldom the case. Even if you are a day trader, it does not mean that you should trade every day. There should be enough reason to take a trade. Remember that every time you initiate a trade, you are putting your capital at risk. Hence, be sure that you do so when the odds of success are in your favor.
5. No Performance Review / Post-Mortem: Similar to any other business, in trading too, you should review and analyse the performance periodically. This would bring to light the mistakes that you commit as a trader. For instance, if you are stopped out too often despite being right about the direction, it is a sign that there is something wrong with your stop placement. Similarly, if you are stopped out frequently before the target gets hit, it could be a sign that either your trailing stop mechanism is flawed or your approach to target placement is incorrect.
Improper stop placement is another typical mistake. Improper stop placement could either make you get out of the profitable trade with a nominal loss or result in a premature exit to a big profitable trade.
I would prefer to address this in a separate post. Expect a post on stop placement soon.
Trade Safe and Don’t Get Hurt
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