Trading is so seductive. You scrape together a little money, pick a hot stock, buy a few shares, and presto! Just like that you can make a mint. Heck you don’t even have to pay commissions anymore thanks to “commission-free” platforms like Robinhood, TradeZero, etc. You can’t go wrong! Right?
At least that’s how many would like to believe it works. And there are countless programs and courses that will tell you it’s just that easy. But ask any seasoned trader and they’ll tell you – that’s just simply not reality.
So to help dispel some of the myths and inaccuracies that are out there, here is our list of the biggest mistakes we see new traders make (and a few of our own are thrown in for good measure!)
Getting their trade ideas from the media
If you talk to new traders, a majority of the time you’ll hear them talk about how they watch CNBC or whatever TV news program and buy whatever is being talked about there. After all, it’s on TV so it must be trustworthy!
Unfortunately even if you believe that nobody on TV has an agenda for recommending a particular stock, the fact is that by the time that information gets to broadcast it’s way too late. The information is already priced into the market. There’s a reason why there is a saying “Buy the rumor, sell the news.”
There’s another old saying in the trading world that goes something like “If you liked it at $50, you must love it at $30!”
The idea this saying conveys is that if you believe in a stock, then you should always buy more if the price drops. This way your average purchase price gradually gets lower, and lower. This is also known as “lowering your cost basis.” There is nothing wrong with wanting to lower your cost basis, and in fact there are very effective options strategies designed to help you do exactly that. But blindly buying more of a stock just because the price has fallen, is foolish.
Take Enron or Bear Stearns, for example. With either of those companies, if you had continued to buy as the price fell you would have eventually lost everything when the companies went under. Averaging down isn’t always bad – it’s an important component of another widely-used strategy known as “dollar cost averaging” (where you buy a fixed-dollar amount of something on a regular schedule, regardless of price). But every trader needs to have a method in place for identifying when whatever they are trading has lost “too much” and it’s time to close the trade. Professionals only buy more when price falls, if it’s a part of their larger plan.
Not keeping their risk consistent
New traders are especially prone to fall into the trap of believing that “this trade will be the big one” and placing a much larger trade than they usually would. They are so confident that this trade can’t lose, that they will sometimes risk their entire account or more.
The problem with that is randomness. Nothing is ever guaranteed in trading, and you can always be wrong. If your “can’t miss” trade actually does miss, and you went “all-in” so to speak, then you stand to lose much more than you can comfortably afford to. By keeping your risk size consistent (willing to risk say 1% on every trade no matter the size of the trade), you will never get wiped out by a single trade going against you.
Buying high and selling low
Everyone knows the idea is to buy low and sell high, right? Then why does the average retail trade consistently do the opposite?
This comes down to human psychology. People love to be part of a crowd, so when “everyone” else is buying that hot stock, you want to also. And when everyone else knows that company is going to zero, your tendency will be to want to sell too (TSLA is a great recent example of this, where extremely “good” news has come out and the price fell hard, then incredibly “bad” news happens and the price jumped up).
What traders need to do, is go by the charts. Ignore news, ignore your friends (unless they are professional traders, of course!), family, coworkers, your Uber driver, etc. The chart is never wrong, and since the public is almost always wrong, you probably want to consider doing the opposite of “everyone else”.
Taking small profits and large losses
Another psychological trading issue, is the desire not to be “wrong”. New traders especially think trading is all about being right, so they resist accepting a loss. They will let losing trades go way too far until they are so big they “can’t” take the loss now.
And on the other side when they have winners, they will cut them short and take the small profit believing “you never go broke taking profits”, when in reality they just cut the legs out from under their profitable trade.
Keeping losses contained so they never cause serious damage, and allowing winning trades to reach their true potential, are two hallmarks of the professional trader.
Not using stop losses
Every seasoned trader knows about using stops. They are simply an order that is placed with your trade, where if the price goes against you a certain amount, the trade is closed and you take the loss automatically. They “stop the bleeding” so that you don’t lose too much.
The key here is automatically. Leaving your exit up to you to personally push the button at the right time, is a sure way to lose a lot. Letting the computer execute your order at the appropriate time without hesitation, doubt, or any question is the safest way to go.
New traders will tend to be so focused on gains that they pay little attention to the possibility of losses, and so aren’t prepared for them. Then a trade goes against them and they freeze, unsure of what to do. A stop loss order will prevent that, getting you out of the trade immediately.
Many brokerage firms now offer products that appeal to the trader with a very small account. Thanks to the concept of leverage, a very small amount of money can actually control a much larger amount. This means that you can effectively trade a much larger amount of money, than you actually have.
Leverage is great, but must be used properly to avoid getting into trouble. When the new trader will often do, is trade the largest size they can, rather than a size that is appropriate for their account. Let’s give an example:
A trader with a $5,000 account decides they are going to trade options. They discover that they can buy an option contract that allows them to control a particular stock, currently priced at $50, for 60 days. The cost of the option in this example, is just $100, and it will control 100 shares of stock ($5,000 worth of stock).
Now they could also just buy the stock, but instead of just buying 100 shares of stock for $5,000, they realize that they could instead buy 50 options contracts for the same $5,000 – but now they control 5,000 shares of stock worth a whopping $250,000!
Now they stand to profit as if they held a much larger position, but what they fail to take into account is the fact that they can (and likely will) also lose their entire account value very quickly. Instead, they should risk no more than 2% of their account – or $100 – which means they can buy a single contract, control 100 shares ($5,000 worth of stock) without risking their entire account.
This is a crude example, but the key point here is to recognize the actual risk you’re taking in your account, and trade appropriately.
Trading too many products
With how easy online trading has become, it’s quite common to see a new trader decide to trade oil futures, index options, a couple of Forex pairs, and some ETFs for good measure. All at the same time! This is a very bad idea. Focus is so important in trading, and getting to know a specific market extremely well, is a crucial component of any long-term trader’s survival in the markets.
Select one primary market you intend to trade, and maybe a secondary one in case the primary has no opportunities currently. Then stick with those two. Get to know them intimately. Understand how they move at different times of day. Are they impacted by any specific news events? Are there any scheduled announcements like inventory reports or economic data that will affect them? Understand what sort of leverage they may deploy if any. Know what your margin requirements are, in the case of futures especially. And above all recognize if these products are well suited to your style of trading whether you’re a day trader, swing trader, scalper, or anything else.
Getting to know just a very small “universe of markets will make it more likely that you learn to trade them consistently, and profitably..
Ignoring taxes & fees
These days trading commissions have gotten so low, that many people just ignore them or think they don’t really matter. But as any active trader can tell you – they add up! Especially if you are trading in a small account, commissions and fees will be a larger percentage compared to your total equity, and therefore must really be taken into account.
Taxes are another area where it’s easy to forget about them. Some products (futures) are easier to report than others (stocks) and some barely even have any defined reporting requirements yet (cryptocurrencies). No matter what you trade, taxes matter and if you don’t factor them into your bottom line, you could easily wind up not being able to pax the government when the time comes, which obviously comes with some very unpleasant consequences.
The best traders are often quite humble, and don’t brag about their results. Professional traders know that it is a never-ending journey of knowledge and experience, and are always looking to sharpen their edge. The moment a trader thinks they are invincible, or “on a roll”, etc. is the exact moment they will probably face some painful losses.
Beware of your own overconfidence as you progress in your trading career. You should improve, and constantly increase your account size. But keep cool about it and don’t let it go to your head!