20 common trading mistakes and how to fix them – Part 3
11. Not having an exit strategy
The trading mistake
If you must play, decide upon three things at the start: the rules of the game, the stakes and the quitting time.
The basic premise is that all traders must know how and when they will exit each and every trade they undertake.
Despite this constant urging, pleading and even begging, being consistent in the exit decision, be it a stop-loss, profit target, or trailing stop, seems to confound the majority of traders, and cause huge amounts of grief and discomfort.
For the majority of traders, taking action to exit trades is perhaps the most difficult part of trading.
It is where the majority of screw-ups and agonising occurs.
Well, a trader can exit a trade:
- Being stopped out.
- Taking profit.
It looks simple. So:
- What is it about exits that causes so much anguish and confusion?
- Why do traders constantly need to be reminded about the importance of exiting trades at a predetermined level?
The fix: Don't think while your trade is open.
Fixing this mistake is very easy, but you will have to accept it fully:
- Trade with a stop loss
- Know how and when you will take profit prior initiating the trade.
First, let’s study the stoploss mistake.
The reason you should trade with an initial stop-loss is to avoid the problem of “thinking again” when a trade moves against you.
Trading without an initial stop-loss in place is the most certain way of losing money that I know of.
To have a mental or hard stop, kidding or saying to yourself, “if prices go below that level I will get out of the trade” just doesn’t work guys.
The reason for that is once the price does go below that level, if you’re long for example, then you still have to fight to get out of the trade because you will look for the price to rally before you attempt to get out of the trade.
The market then maybe stages a bit of a rally and you think, “great, the trade is now going as I thought it would’, so you hang on, still without a stop-loss in place.”
Then, market trend resumes and your loss increases… whereas with a stoploss, you admit you are wrong immediately, and it’s done.
Yes you have to accept the loss. But you can trade again tomorrow.
Secondly, similar to setting stops, when aiming for a profit target to exit a profitable trade (usually the domain of short-term traders) there is always the temptation to override the “system”.
You may want to hang on to a winning trade that has already reached the target price in the belief that it will go higher still, resulting in an enormous profit that will fulfill the dream of a five-star world trip.
This may be the case occasionally, but as professional traders know, grabbing the predetermined profits is what short-term trading is all about.
Hanging on to trades for longer periods in an attempt to squeeze every last drop of profit out of the trade is not what short-term trades are aiming for.
Doing this usually ends in frustration and anger.
If you are struggling, you should define the context of your trade in order to know when to let your trade run, and when to quickly take profit.
In order to avoid leaving too much profit on the table, why not use dynamic rules instead of a predefined price level?
And if you want to limit your emotions while in a trade, we advice you to cut ¼ of the trade quickly, and let the remaining follow your initial plan.
A little peace of magic to help you is to realize that the markets are full of imperfection, so keeping your exit strategy consistent and mechanical will preserve you from regrets.
You won’t buy all the bottoms & you won’t sell all the tops.
Accept and deal with it.
12. Listening to the advice of media and others
The trading mistake
Our world is awash with financial news and opinion.
Turn on the TV or scroll the web, and a trading beginner can only fall in love for the last TV show, chat rooms and websites devoted solely to the delivery of financial information.
These media “talking heads” are happy to voice their opinions on everything – commodities, stock prices, currency valuations – and these opinions generally change on a whim.
Most market commentators tend to be either reactionary or predictive in their opinions.
They will comment on a price move well after it has occurred or try to predict the future direction of prices with any available data that supports their viewpoint.
These latter commentators tend to fall into the “hero” category, attempting to be the hero that calls the bottom or top of a market move, so they can shout “I told you so” to anyone who will listen.
The hard reality of trading the markets is that our decisions are quickly validated to be good or bad, right or wrong, winners or losers.
That’s very hard for some people to handle.
We have to accept responsibility for our decisions; it’s very black and white.
On the whole, people are challenged by accepting responsibility for their actions.
Take a look at how many lawsuits there are against bars or nightclubs where a person got drunk and sued the owners for letting them drive drunk.
But one simple question: Why do you assume they are better than you?
By making this assumption, you are literally letting unknown people and their unverified skills manage your own money.
The fix: You are better than you think.
A major issue with these market commentators, analysts, brokers, economists, and anyone else expounding a theory on future prices is the lack of accountability.
It is quite common to hear these supposedly well-informed opinion givers expressing negative and bearish opinions and commentary one week, only to be positive and bullish the next week, with no reference to their comments of the previous week.
This chopping and changing of opinion and lack of accountability needs to be considered by anyone using these opinions as the basis for their decisions to buy and sell.
Having a well-researched and tested system or strategy for engaging the markets is a big step towards and the only path to success.
Despite this, many traders and investors still look to the media for market news and information and often base their trading decisions around these stories and opinions.
The only way to be successful for traders, is spending time trading and back-testing their ideas.
Be focused and disciplined in your trading pursuits, and put the hard work.
Let’s take the study of violinists by K. ERICSSON.
Ericsson divided a school’s violinists into three separate groups:
- the stars (those expected to excel);
- the good performers;
- and the group that was not expected to ever play professionally.
All violinists were about five years of age when they started playing.
All groups practiced about the same amount of time (two to three hours a week).
Those who began to practice about six hours or more a week began to excel.
This same pattern continued up until the age of 20.
The elite performers (in all groups) were practicing over 30 hours a week, some almost totaled 10 000 hours by age 20.
Those who remained good players practised a total of about 8000 hours, and the future music teachers a total of 4000 hours.
When compared with professional pianists, they saw the exact same pattern.
The professionals steadily increased their practice time every year.
The striking thing about Ericsson’s study was that he and his colleagues couldn’t find any naturals musicians who floated effortlessly to the top while practicing a fraction of the time their peers did.
Just as the violinists who took the extra responsibility to practice more than their counterparts were the ones to reach professional heights, so it is with traders.
Those who put in the hours of practice and hard work, and take responsibility for all their trading and life decisions will reach heights that others will only ever dream of.
The best way to learn and educate yourself is to spend time with charts.
Copy the methods of educators who actually make money trading.
Not someone who has a slick brochure that promises to make you a millionaire next week.
Learn from several educators then spend time trading. There is no need to reinvent the wheel or method by yourself.
And know your numbers as we mentioned previously. Your trading system and the quality of it will build the confidence you need to only listen to you and avoid external bias.
Successful traders implement strategies that work and have a proven positive statistical advantage over the long term.
Just as in any of life’s endeavours, there is no “easy way”.
By the end, after putting the hard work, why to trust unknown people instead of you and the hard work you put?
13. Averaging down
The trading mistake
As a retail purchaser there is absolutely nothing better than getting a “bargain’.
This desire to pay anything other than full price for any item appeals to a deep-seated feeling of victory over the seller that resides in all of us at some level.
Unfortunately, it can work against us in the trading arena.
The price of a stock or futures contract that was $20 and is now $10 is not necessarily “cheap”.Nor is it a good deal if it subsequently drops to $5.
The punters that fall for this fallacy are victims of the often touted but ill-advised theory of “averaging down” or dollar cost averaging.
Anyone participating in this activity has little or no understanding of risk management, money management, bear markets and trend recognition.
Why ? Because the big issue with a falling market is that we can never know where and when it will end.
There are countless examples of brokers, gurus and other so-called experts attempting to pick the bottom of the market who become remarkably silent when prices tumble further and further into the abyss.
Downtrending markets are like a huge glacial crevasse. You may fall in and land on a ledge several metres below the surface.
Hanging on for your life, you suddenly feel your grip loosen and you drop several meters lower before landing on another small ledge.
Bear markets are like this.
They will drop a bit, consolidate for a while, and have everyone convinced the worst is over, only to drop again as the ledge gives way and the sellers regain control.
This may happen several times with various experts calling for the bottom each time one of these ledges is reached.
Unfortunately, we don’t know we have reached the bottom until some time later when we can all look back with authority and say when it occurred!
Those who average down during these times will be punished by the market, many losing substantial sums of money in the process.
Those using leverage will be particularly hard hit as they will be forced to sell shares and maybe even other assets and investments to meet the margin calls required to fund their deteriorating, over-leveraged share market positions.
The fix: Ride the trend and just make the money
Trend recognition is vital to success in any trading and investing activity.
Reduced to its simplest form, technical analysis can be defined as buying in uptrends and selling in downtrends.
Averaging into the price of a contract position during a bull market when the general trend is up makes sense.
But it is a foolhardy approach in a bear market when prices are getting smashed.
Being able to recognise the price trend is extremely important.
The majority of stock market participants adopt a buy-and-hold strategy and convince themselves that they are in it for the long term.
Many stocks that reach dizzying heights during bull markets are often wiped out during bear markets.
It is impossible to know what will happen in the markets.
Technical traders and those with a trading plan know when it is time to exit trades either on initial stop losses, trailing stops or profit targets.
They are able to exit trades as and when required and know not to re-enter the market until their desired set-up conditions are met.
In this way they do not hold onto losing positions, and are never drawn into averaging down.
Disciplined traders will sit on cash until market conditions again become suitable for their trading strategy, or employ multiple strategies across multiple markets to profit from moves in other markets.
Failing to get out of trades, averaging down into losing positions and hanging on to positions in a bear market not only erode your physical capital but also your emotional and psychological capital very quickly.
You just get wrecked holding a long position in a bear market. Make the money, and go away.
14. The lack of discipline
The trading mistake
A great deal of self-discipline is required to ensure that you consistently engage the markets according to the rules of your system or trading plan, even in the tough times when the system is in a drawdown or out of whack with the market. It is during these times that one’s abilities as a trader are put to the test.
The temptations to ignore signals or to randomly increase or decrease position sizing or, worse still, randomly execute trades based on ‘gut feel’ must be ignored.
It is when the chips are down that the rules of your system as detailed in your trading plan must be adhered to meticulously.
This is when your money and ego are on the line and the decisions you make will affect what happens next.
How you will react in good times and in bad can only be discovered through experience. This is when the concepts in your trading plan will be tested, as will your discipline to be able to perform under pressure.
Avoiding the temptation to meddle with the strategy is a must.
Despite the viewpoint of many that trading can be taught to everyone (which it can in theory), not everyone will be suited to the rigorous mental activity and high level of self-discipline required when actively trading.
Sure, everyone can learn how to do it, but not all will have the discipline and continued desire to apply themselves to the markets consistently over time.
Equally important as learning how to trade is knowing when to stop trading if it is not working out.
The majority of these issues arise from a discretionary or arbitrary approach to trading.
The fix: Mindfulness
Experienced traders are well aware of the importance of managing their trading psychology.
Through keeping their ego in check and working on understanding how they react under pressure and handle their own thought processes, they are able to reach a point of emotional detachment from the outcome of their trades.
Much of this can be attributed to the application of a robust trading system with a clearly defined “edge” and money management techniques coupled with the ability to practice mindfulness.
Mindfulness is basically watching and monitoring their own thoughts.
Those who are able to achieve this state of mindfulness become separated from the actual processes of analysing the markets and trading.
It is almost as if they are totally uninvolved and detached from the process.
They are able to virtually watch themselves trade and observe their emotions and reactions to what is happening.
They are able to watch themselves from an external locus, performing the trading activities but remaining detached at an emotional level.
Very few people can achieve this state consistently. And this is where meditation kicks in.
15. Emotional trading
The trading mistake
When your trading relies on tips from mates and brokers, the latest and greatest magical indicator, or whatever else seems appealing at the time, it can’t end well.
Traders using such an approach, with no clearly defined set of rules for market engagement are constantly chopping and changing their trade entry and exit rules as well as their position sizes and risk tolerance with absolutely no consistency in their decision-making processes.
Their whole strategy is virtually a random series of events – some that work and some that don’t – with most winning trades with most winning trades attributed to good luck rather than any particular level of skill or ability as a trader.
One trade entry will be based on an indicator crossover, while the next will be based on a chart pattern, and the next on a bit of “insider information”.
Much more dangerous, however, will be the random methods by which trades are exited.
While trading in this way may appear to work for a short period of time or during a specific set of market conditions, over the long term it is doomed to fail, not only because market conditions will change, as they always do, but also because the demands on the trader to continue to engage the markets in this way are time consuming, stressful and all-encompassing.
Discretionary trading requires the trader to be constantly in contact with the market, constantly monitoring any number of chart patterns, indicators, phases, count-back levels, and whatever combination of methods they are using to somehow arrive at their entry and exit decisions.
This is mentally and emotionally exhausting.
Decisions made for a trade that “works” and returns a profit result in feelings of euphoria and happiness.
When the same decisions result in a losing trade, feelings of frustration and anger occur.
While it is possible to achieve a decent rate of return when trading in a discretionary manner during a specific set of market conditions, it will not deliver consistent outperformance over the long term.
Discretionary traders usually achieve their best results during bull markets and extended uptrends, and tend to fall into the trap of believing that, first, the uptrend will continue, second, that they will continue to profit from their strategy, and, third, that trading is easy.
In trading terms they are referred to as ‘mistaking brains for a bull market’.
When the market conditions change, their ‘trading’ ability comes under pressure, the number of losses increase, and they are eventually wiped out or stop trading. At best, they significantly underperform the market.
The fix: Be mechanical and stop overthinking.
Mechanical trading aims to eliminate these subjective decisions and replace them with an objective and disciplined approach.
Mechanical trading systems can range from highly developed mathematical algorithms that auto-execute trades from a live trading platform, to using chart-based patterns or simple indicator crosses and other triggers to enter and exit trades.
Whatever method is used, it can only be considered a “system” if a strict set of rules or conditions exists, and entries and exits are taken consistently and constantly, without rationalising the trade.
The thinking stage needs to occur during the development of the system.
Once it is developed, tested and fully understood, then it must be simply applied to the market and adhered to 100 per cent of the time.
This is obviously much easier when using a fully automated system that sends orders electronically to the market without the trader having to actually manually place the order.
If it is a system or a market that requires the trader to place the orders manually, then these must be placed every time, regardless of any thoughts the trader may have as to the appropriateness of the trade.
When using a mechanical system, it is important to avoid attempting to “cherry pick” trades.
This term is used to describe the temptation to attempt to pick the ‘best’ trades and bypass those trades considered to be irrelevant.
This almost always ends in disaster as personal bias will influence the decisions and result in the trades taken actually bearing no correlation with the overall results of the system.
It is a common mistake made by many new system traders, and usually unfolds along these lines.
The real trick to mechanical trading or trading a system is to buy or develop one that suits your personality and trading style.
There is little point attempting to trade an aggressive short-term system that generates frequent signals if you are more relaxed and looking to capture long-term trends.
It is also important not to over-optimise a system, so that it appears on paper and from back-testing to be the perfect answer to all your trading requirements.
This is a process known as “curve-fitting”, where the system is built to fit the existing historical data. Invariably, these systems will fail once live trading commences.
Consistent traders have learned to think in terms of probabilities and the long-term performance and returns of their trading system delivered as a result of its ‘edge’.
The outcome of individual trades loses relevance and is replaced with an understanding that winning trades, losing trades, drawdowns and new equity highs are all just the probabilities of the system playing out in real time.
They are “normal” occurrences that the trader accepts and has trained for.
They actually expect them to happen and are able to deal with the range of outcomes that can occur through studying and understanding both the system they are trading and, most importantly, themselves.
The importance of testing a system over a large sample size becomes critical.
To be continued...
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