Last Updated on Friday, 14 February 2014 01:09 GMT
Saturday, 20 October 2012 22:26

Common Mistakes in Trading

Every trader has different psychology and personal traits but still there are some trading mistakes which traders make quite commonly. On one side we need to check on personal characteristics to have a better discipline in our trading but on the other hand we also need to focus on avoiding these common mistakes. Avoiding these mistakes is the first step for building a successful trading career.

Top Trading Mistakes

My trading mistake or someone else's fault?

1. Always entering the market against Trend

It may happen that the market go into a trend in the opposite direction than what we might have thinking. We might have been thinking that the price would fall but the price starts going up. In such situations we tend to hope that sooner or later the price would fall and with every big move we try to short-sell. What actually happens that the trend continues and out trades end up in loss by hitting the stop-loss orders. What we are doing is ignoring the facts that the trend is strong and becoming a slave to our emotions and hope against all the analysis and the facts.

Such actions are possible from time to time and at times our judgment may prove to be correct. However, if this loss-making continues as a pattern then it needs a deeper analysis and better control over our trading decisions.  

We can't rebel against the market rather we need to understand it and be with the flow of it. Also markets movements cannot be predicted every time because it is not run and controlled by definite factors and a small group of entities.

Every trend reverses and its always a cycle but what is important is to try to figure out the levels where it may reverse and not just to keep going with our emotions and egos.

2. Taking a position too late

Some of us take risks easily while some of us are risk averse. The extreme to any side goes against good trading decisions. If we are a completely risk averse person then speculative trading is not meant for us. Forex trading is not our game then because we would tend to see 100% confirmation of the market trends. The fact is that in dynamic markets like Forex market there is nothing for which you can be 100% sure. When we enter the market (buy or sell), there is always a risk. We need to take optimum risks than to keep on waiting for confirmation and reconfirmation about the trend because by the time we decide to take a position the prices may be on the verge of reversal.

The opposite of the above is also true and that is to take a position too soon.

3. Adding trade positions against the trend

This pattern takes place with those of us who are weak in facing any kinds of losses or are gamblers in nature and also have high egos.

Let's assume that we take a long position. Instead of going up as we had expected, the prices start going down. We are so bound by our emotions, hopes and egos that we are sure that the prices are going to move up. We are so sure that we take it as an opportunity to buy more so that our profits would be more. We immediately buy more. It goes further down and we still buy more. Now either we get thrown out of the market because of a margin call or by the time we decide to come out the losses are already too big.

This mainly happens because we become too egotistical to accept that we were wrong. As soon as the market starts telling us that the decision could have been wrong, the combination of the fear to lose, the ego that how could we be wrong and the fear to lose come into the play. This results in either buying more as an effort to maximize the profits or thinking that a slight reversal would at least balance the loss we might make on our first position.

In certain situations adding to your losing positions may get you nice profits. It generally can happen when market has gone too far in one direction and a reversal may be around the corner. But if such actions take place as pattern in different kinds of market situations, it would just wipe out the accounts, certainly, on one fine day. As they say that the trend is a friend and being cautious is better than being caught in complete uncertainty.

No one can be emotionless but emotionless but a trader needs to be in control of the emotions. Egos will be there, greed will be there and fears will be there but how to balance those out by controlling those so those emotions work in our favor and not against us is the key for the success.

4. Trading addiction and trading with emotions

Trading is a serious business - Simple Mistakes can make your balance sheet red.

By nature some people are prone to addictions while some have better abilities to avoid addictions in life. If we are prone to addictions then there is a good possibility that trading may become an addition. It should be avoided at all cost. We need to take trading positions when we are pretty sure about a directional move and should strictly avoid to trade just for the sake of trading. We do not have to be in the market all the time. The trading platform is not a video game. Working on our platform is serious business. It’s our hard earned money which we are putting in the trade and that needs to be put to earn more and not to keep us engaged.

There are times when we are not at all sure about the market behavior. The price action may either be just running in a very narrow range or it may just be having a very volatile moves lacking in a clear direction. Because we are addicted to our trading and can't keep ourselves away, we take positions just because of hope without the backing of a real analysis or logical reasoning. This may prove to be very costly if this happens in a pattern, time and again,

There are times when it is better to be away. Always ask the following questions before taking a position:

  • Am I reasonably sure that the market would move in the direction I am expecting?
  • If I am reasonably sure then what are the reasons/logics backing my decision?

5. Stop-loss orders too close or too far

  • Stop-loss orders too close: We may be subconsciously or consciously worried that market may move against the direction of our position and we want to cut our losses to the minimum. This may make us having a very narrow stop-loss order.
  • Stop-loss orders too far: We may be subconsciously or consciously worried that market may move against the direction of our position. And We don’t want to have our stop-loss order closing the position before the market reverses and moves back in the expected direction.

Well, in both the cases there is a feeling in the sub-conscious mind that market would go against our expected direction. The first thing is that in such cases we should avoid taking any position or should use limit orders rather than market orders. In case we are reasonably sure that price action may have some consolidation before going in the expected direction than the stop-loss levels should be optimum otherwise either we certainly make a loss or make a big loss.

6. Take-profit orders too close or too far

Take-profit orders too close:

When we are worried that the market may have some consolidation in the opposite direction very soon than what we are thinking and but still we wish to trade and make some profits.

Take-profit orders too far:

Trying to kill all the birds with one shot? Make all the money with one trade?

Same as what we talked above about stop-loss levels, either we should avoid taking a position or put a limit order rather than a market order. Take-profits should be optimum . Very narrow take-profit targets would be like cutting down the opportunities and make a loss in the possible profits and very high profit targets may cause the market reversal before the target hits and may cause a loss ultimately.

Nobody becomes rich in one day. The markets move in a cycle. Even during a strong trend the prices will have corrections before the move continues. And we cannot be absolutely sure whether it would prove to be just a correction or a reversal.

Keeping the take-profit orders too far with too much optimism is dangerous. And keeping those too low for quick profits is also equally dangerous. There is nothing like a quick profit or too much profit. Being reasonable only brings us reasonable profits.

7. Learning from the past mistakes and making a bigger mistake

Learning from past mistake is always required but not in the absolute terms. In a dynamic market like Forex, what was true last time may not hold good in the current, and possibly changed, situation.

One example of this was mentioned earlier in this write-up that we put stop-loss order very close in one trade, the market goes against us and our stop-loss order closes our position with a loss. After hitting the stop-loss level, the market reverses and goes in the previously expected direction. We learn from this mistake and next time we put the stop-loss very far. The market goes against us and keeps on going against. We end up having a much bigger loss..

There could be various ways that we can make such mistakes. Suppose we have been expecting the market to go up. We buy but it goes down and we make a loss. We buy again and make further loss. After some time we get frustrated and we short-sell. The market moves up and well, another loss. Every new trade is a fresh start. Learning from the past failures and successes is important but those failures and successes should not influence the current trade. Every trade is different and every situation is different and we need to apply our past learning and experiences according to the situations and not in a literally and absolute way

In a dynamic market the strategies also need to be dynamic. Checking and rechecking the decisions about the entry points, exit points, where to put stop-loss and what should be the position size are very important and should change with the changing market conditions. We need to see if any of these decisions is getting influenced by past losses or past profits.

8. Loving our trades and bias for the market direction or numbers

As far as loving our trades and bias for market direction is concerned, it is similar to point number 3 above. Many of our trading decisions would go wrong and that’s the reason that a good risk-reward ratio has to be maintained so that the profit margin of each trade is more than the possible losses. This was even if 50% of our decisions go wrong, we end up with a net profit. If we are biased about the market direction and love each position we take trades, we would fail to hear what the market is telling us. It’s important to hear what the market is indicating than to go ahead with only what we think.

Apart from the direction we need to avoid any bias about the numbers. We may be biased about the numbers in two ways. Bias for the price of any currency pair or about the profits we want to make out of a trade or during a period of time.

  • Bias for the price level: Sometimes we may get stuck with the idea that certain price level is the normal price level for a currency pair and the pair would come back to that level regardless of the current movement. For example if we have seen USD/JPY to move a lot in the range of 115 to 125, we may start thinking that 115 should be the normal level for this currency pair to reach even if has gone down suddenly to 110. Well, that may happen but what may also happen that the downtrend continues and the price goes to a new low. There is nothing which can be considered as the "average" in the market. Prices can go to all time high and crash to unexpected bottom. Market always has surprises for us and we need to be ready to take the surprises.
  • Bias about the profit levels: Well it may happen either when we have made some good profits in the recent past or have made big losses. We may end up setting some impractical or unrealistic profit targets for each day or week or month. Doing such a thing only creates unnecessary pressures and the resulting stress may result in wrong decisions and hence loss making trades. Out of the panic that we are not meeting our targets, we could make some more wrong decisions and that would further add to our losses. A goal for desired profits is required but not for very short periods like every day or every week. Do it for little longer time frames. And even if you wish to do it for shorter time frames, don’t panic. It’s the average profitability which counts. Fix up the goals but don’t panic.

9. Trading too big for the account size

It’s practically impossible to buy when the prices are at the rock bottom and take profit when they are at the peak. Similarly it's not possible to get the peaks for a short-selling trade. In other words it’s simply not possible to pick the peaks and bottoms most of the time. It is always possible that even though our analysis was good but after entering a trade price may move in the opposite direction for some time. If the position size is too big then those few pips in the opposite direction may wipe out the account. Always keep an eye on your trading account size and keep an eye on the margin requirement.

We should not just think as to how much we can make but also keep in the mind as to what could be the possible losses.

10. Varying the trading position size

Let's assume that we are continuously in profit and we multiply our position size in the next trade and it goes in opposite direction. Or we are losing continuously and we decide to multiply our position size expecting a gain which would balance our previous losses. The third example could be that we are continuously gaining and we make our position size very small for the fear of losing in the next trades and end up smaller profit than what otherwise we could have in this winning trade. Once we realize that we could have made more and lost the opportunity, we enter into a very large position and end up making a big loss in that trade.

It never pays in varying the position size because of panic, greed, optimism or pessimism. Keeping the position size balanced, not only thinking of what we can lose or gain but what profit size is reasonable and how much loss we can afford reasonably is another key for long-term success.

11. Not looking at the long-term and short-term pictures of the market

Let's say that we are following only the daily chart, and our analysis on that gives us a clear indication that the price is having a strong uptrend and there is an opportunity to take a long position right now. Now at the same time a shorter-term chart, say 4-hourly or hourly, may be giving a signal that there is a possibility for some downward consolidation. In case we put a trade just on the basis of the readings of the daily chart then we may either miss the opportunity to make some larger profits or put a wrong stop-loss order which may close the position before the prices move up again.

The opposite of the above is true that a decision based solely on a short-term chart may prove to be wrong. Keeping an eye on both, the shorter-term situation and longer -term situation make the decisions better.

12. Trading without stop-loss order- THE ULTIMATE KILLER

The only thing we would like to say about this point is that “SIMPLY DON’T DO IT”.

You may be afraid that the market going may go to the opposite direction before it goes back in your expected direction or you may be too confident that even if it goes in opposite direction, it would go back in your expected direction. Well, both fear and confidence here are pointing towards the same thing that you are not confident about your decision. But even if you are confident, PLEASE PUT A STOP LOSS ORDER AT REASONABLE OR EVEN UNREASONABLE LEVEL. If you don’t like it, it's better to stop yourself from trading otherwise one day the market will stop you forever.

Understanding ourselves is the first step before we try to understand the market. If we can overcome these common mistakes in our day-today trading then half of our job is done.

For going back to psychology section please click at Trading Psychology and Discipline.

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