Top 10 Trading Pitfalls You Must Avoid
Avoiding the following 10 investing and trading pitfalls will spare you enormous mental anguish and ensure your financial health.
- Trading without a plan. Always have your trading plan written out and in front of you when you are trading.
Your trading plan is your trading strategy to which you will adhere to in all your trading and investing activities.
If you do not have a plan, you will not succeed. Without a plan, you invite all sorts of trading problems.
You will succumb to every whim and fancy in the market and be swayed by every market gyration.
Go here to learn how to how to plan your trading strategy from scratch
- Emotional investing. It’s natural to get caught up in the momentum and want to trade on emotion.
However, you must avoid the emotion and stick to your plan. You will likely make mistakes as a beginner so start small and that is the time you are more likely to succumb to Trading pitfalls. Fear and greed are two of the most powerful emotions. They can work for you as well as against you.
Fear could paralyze you and prevent your from executing you strategy the way you planned, for instance, causing you to panic and getting you out too early.
Greed could cause you to stay in longer than you should. There is a saying that Bulls make money, Bears make money but Hogs get slaughtered.
- Timing Tops and Bottoms. Trying to sell at the absolute top or buy at the absolute bottom is a difficult thing to do and you will be wrong more often than being right. It’s better to wait for confirmation of a trend or reversal.
Note: You will be a little late getting in but you should be catching the early part of the trend and that can prove to be very lucrative as well as avoiding common trading pitfalls.
- Failing to use hedges. The Market giveth and the Market taketh. The market will not always perform the way you want. Failing to use protection will increase your exposure to market risks .
Regardless of how much money you make, if you fail to protect it, the market will take it back.
Two hedges you can use are:
a) Protective Stops. Give yourselve the opportunity to get out of the stock if it moves against you.
Note: If you are long a stock, you will not be protected from a gap down but it gets you out at the first opportunity.
Find a reasonable support level and put your stop at some percentage below in case it violates the support level. 3% below support is reasonable.
b) Option Protection. When you buy an option, you lose whatever time value and volatility value is built in to the stock. That is, it “wastes away” but if the stock gaps, you are covered.
Go here to learn more about managing risks
- Improper position size. The purpose of that is that you do not put too much capital in one trade. That increases your risk. For example, use no more than 5% of your portfolio for 1 stock and the amount of risk should be even smaller.
For example, if MSFT is trading at $29 per share and support is $26, and you set your stop at 3% below support, then your stop will be placed at $25.22. Your risk per share is $29.00 - $25.22 = $3.78. Therefore, for 100 shares, your risk will be $3.78 x 100 = $378.00.
- Trading against the trend. This is hazardous to your wealth. That’s like a salmon swimming up stream. Trading pitfalls can be avoided if you view the trend is your friend and embrace it.
Go here to learn about trading with the trend
- Trading on Tips. As soon as you tell someone what you do, they generally have some trading advice and tips for you. Your family is no exception. Do your own research, do your own due diligence, set your own risk, know when to buy and when to sell.
- No patience when trading. Do not set your time horizon too short. Wait for whatever discipline that you set to develop. You’ll miss some opportunities. Don’t bother about that. You don’t have to make all in order to be successful.
- If you’re not sure, don’t trade. This is one of those trading pitfalls where you feel pressure to make a trade because it looks like you are missing an opportunity. Also, if the conditions that you establish in your plan are not met, do not Trade.
- Never, ever straddle a loss. The market will sometimes move against you. Don’t make it necessary for you to be right twice rather than once. A loss by itself is difficult enough to accept.
Neither should you lock in this loss,. e.g. when market pulls back, you panic and buy a covered call.
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