Trading can be a rewarding way to make money, but it also comes with many challenges and risks. Many new traders enter the market with high hopes and expectations, but end up making costly mistakes that derail their trading journey. In this blog post, I discuss seven common mistakes that most new traders make and how to fix each one.
1. Going in unprepared
One of the biggest mistakes that new traders make is jumping into the market without doing enough research, preparation, and practice. Trading is not a game of luck or chance, but a skill that requires knowledge, analysis, and, above all, an unshakeable belief in your strategy. If you go in unprepared, you're likely to lose all of your money fast and get frustrated.
How to fix it: Before you start trading, you should learn the basics of the market, the instruments you want to trade, the trading platforms and tools you will use, and the trading style/strategy that suits your goals and risk tolerance. You should also have a clear trading plan with verfied setups that outline your entry and exit points, your risk management rules, and your performance metrics. Finally, you should practice your trading strategy exhaustively on a demo account before risking real money.
2. Lack of proper tools [and understanding of how to use them]
Another mistake that new traders make is not having the proper tools and resources to trade effectively. Trading is more art than science and just like any craft, it requires the proper tools and resources. Without them, you're handicapping yourself and limiting your potential.
How to fix it: You should invest in a reliable computer, a fast internet connection [redundant if possible], and a reputable broker that offers low fees, good customer service, and a focus on your trading instrument of choice. You should also use trading software and tools that can help you analyze the market, execute your trades, manage your risk, and track your performance. Some examples of useful trading tools are charting software, indicators, scanners, alerts, calculators, journals, and mentors.
3. Going in too big aka overtrading
Another mistake that new traders make is risking too much money on each trade or having too many positions open at once. This can lead to overtrading, which is when you trade too frequently or impulsively without following your trading plan or strategy. Overtrading can result in excessive fees, emotional stress, poor decision-making, and large, exagerrated losses.
How to fix it: You should trade in relatively small amounts that won't cripple your trading account when you experience the inevitable trading losses and limit the number of positions you have open at any given time. You should also follow the rule of thumb that you should never risk more than 1% to 2% of your trading capital on any single trade. This way, you can protect your account from large drawdowns and preserve your trading capital for future opportunities.
4. Following vs. learning/developing
Another mistake that new traders make is following other traders blindly without learning from them or developing their own trading skills and style. While it can be helpful to get tips and advice from other traders who are more experienced or successful than you [i.e., mentors], you should not rely on them entirely or copy their trades without understanding why they are doing what they are doing. Doing so can expose you to unnecessary risks and prevent you from developing your own trading edge.
How to fix it: You should use other traders as sources of inspiration and education, not as sources of signals or instructions. You should learn from their successes and failures, but also do your own research and analysis before making any trading decisions. You should also develop your own trading style and strategy that suits your personality, goals, risk tolerance, and market conditions.
5. Averaging down
Another mistake that new traders make is averaging down on losing positions in the hope of recovering their losses or breaking even... also known as a Martingale Strategy. Averaging down is when you buy more shares of a stock that is falling in price to lower your average cost per share. While this may seem like a logical way to reduce your losses or increase your chances of making a profit when the price rebounds, it can [and often does] backfire and magnify your losses as price continues to move against you.
How to fix it: You should avoid averaging down on losing positions unless you have a valid reason to do so based on your trading plan or strategy. Instead of adding more money to a losing trade, you should cut your losses quickly and move on to the next opportunity. You should also use stop-loss orders or other risk management techniques to limit your downside risk and protect your account from large losses.
6. Not cutting losses
Perhaps the biggest mistake that new traders make is not cutting their losses when they are small and manageable. Instead, they hold on to losing positions, waiting for the position to return to breakeven/hoping that the position will turn around and become profitable. This often results in large and unnecessary losses that can wipe out a trading account. Cutting losses quickly when they're relatively small is so important that it's considered by many the main source of the trading fortunes of traders such as Steven A. Cohen and Jim Simons.
How to fix it: You should always have a predefined exit point for every trade you enter, based on your trading plan and strategy. You should also use stop-loss orders or other risk management techniques to limit your downside risk and protect your account from large losses. A stop-loss order is an order placed at the exchange to cut off losing trades at a specific price point. For open long positions, a sell stop-loss order is placed beneath price action; for shorts, buy stop-loss orders are placed above price action. A more advanced way to go about it is using the hedging strategy, which involves taking an opposite position to your original trade to offset the risk⁵.
Cutting losses is not easy, as it requires discipline and emotional control. However, it is one of the most important skills that you need to master as a trader. By cutting losses short, you can preserve your trading capital and live to trade another day.
7. Revenge trading
Revenge trading is a common pitfall that many new traders fall into when they suffer a big loss or a series of losses. It is an emotional reaction that makes them want to recover their losses quickly by taking another trade without following their strategy or risk management rules. This can [and often does] lead to even bigger losses and damage to your confidence and trading account. I'm spending a bit more time on this mistake below because it destroys more trading careers than all of the others combined.
Revenge trading can be caused by various factors, such as anger, greed, fear, shame, overconfidence, lack of awareness, poverty mindset, or not knowing/understanding the probabilities of a trading strategy. These factors can trigger a loss of emotional control and make traders act impulsively and irrationally.
Revenge trading is dangerous because it can:
- Make traders trade according to their emotions rather than their logic and strategy
- Make traders forget their entry and exit criteria and trade randomly
- Make traders ignore their risk management rules and risk too much per trade
- Make traders chase the market and enter at unfavorable prices
- Make traders lose sight of their long-term goals and focus on short-term gains or losses
- Take a break or trade smaller until you figure things out. If you feel yourself getting emotional after a loss, stop trading and do something else. This will help you calm down and regain your composure. You can also reduce your position size or switch to a simulated account until you feel confident again.
- Develop more awareness while trading. Be mindful of your thoughts, feelings, and actions while trading. Notice any signs of frustration, anger, fear, or greed that may cloud your judgment. Use a trading journal to record your trades and emotions and review them regularly.
- Review your strategy, execution, and market conditions. Analyze your losing trades objectively and see if they were caused by your mistakes or by unfavorable market conditions. If you made mistakes, learn from them and improve your execution. If the market was against you, accept it and move on. Don't blame yourself or the market for your losses. If the loss was just normal course of business, then accept that and move on as well.
- Implement the 2-strikes rule. Set a limit on how many consecutive losses you can take before you stop trading for the day, week or month. This will prevent you from overtrading and digging yourself into a deeper hole. For example, if you lose two trades in a row, call it quits and come back later.
- Identify your cue and reward. Revenge trading is a habit that is triggered by a cue (such as a loss) and reinforced by a reward (such as a win or a relief). To break this habit, you need to identify your cue and reward and replace them with healthier alternatives. For example, instead of taking another trade after a loss, you can reward yourself with a snack, a walk, or a positive affirmation.
- Implement behavior conditioning. Behavior conditioning is a process of changing your behavior by using positive or negative reinforcement. You can use this technique to discourage yourself from revenge trading by imposing a penalty for every time you do it. For example, you can donate money to charity, do push-ups, or delete your favorite app for every revenge trade you take.
- Use a positive market metaphor. A market metaphor is a mental image that you use to describe the market and your relationship with it. A negative market metaphor can make you feel hostile, fearful, or powerless towards the market. A positive market metaphor can make you feel friendly, respectful, or confident towards the market. For example, instead of seeing the market as an enemy that you need to beat or get even with, you can see it as a partner that you need to cooperate with or learn from.
Conclusion
Trading can be an incredible way to make money in both the long and the short term, but it also comes with many challenges and risks. Many new traders make the common mistakes listed above [and more] that can cost them money and discourage them from developing as traders. However, by avoiding/minimizing these mistakes and following some simple rules, you can improve your trading performance and achieve your financial goals.
