As a new trader it is helpful to learn from mistake made by others. The following are several of the most common trading mistakes (in no particular order) made by new investors that you should avoid. In truth, a lot of these examples affect even more experienced investors.
Common Trading Mistakes
- Trading on Momentum: Even though this list is not in order, I could easily make a case that “momentum trading” is the number one obstacle to successful trading for retail investors. As it is fueled by emotions (gleeful buying and/or fearful selling), it contradicts the tenants of disciplined trading and the value of technical analysis. Institutions and market makers feast on momentum buyers who acquire shares at a premium, and hand over shares cheaply due to panic selling.
- Failing to Take Profit: The old adage “shoot for the moon and you can still land among the stars” doesn’t necessarily apply in trading. Unfortunately, many traders shoot for the moon, and end up wishing they took profit among the stars. Swing trading centers on your ability to enter positions at ideal entries and exit with good profit ahead of resistance levels. Often, fast-moving trends quickly reverse. This point is especially true in small-cap/penny stocks. If you are too greedy with your price target and fail to take profit, you likely end up back where you began (and stuck there for some time). Scaling out of a position by taking some profit (and riding with the balance) at incremental resistance levels is one strategy. Other traders maintain a core position for the big score and swing trade small moves with other funds.
- Exiting Too Early: Closely related to failing to take profit, new traders (and even experienced ones) often exit profitable trades too early. This point is especially true if you have waited patiently (or even not so patiently) for a stock to get out of the mud. I often see traders post comments about “getting out as soon as the price reaches…”. This point of view is exactly how power players want you to look at things. Flatline accumulation requires patience, and it typically occurs because institutions need time to scoop up shares at a discount price before the share appreciates. This mistake also ties into momentum trading. Establish your price targets or resistance levels in advance to take a more disciplined approach.
- Trusting Level II Data: Every broker and financial service site pitches (free or paid) subscriptions to Level II data. Level II shows bid and ask prices at the top of the order book. I am not saying you shouldn’t explore Level II or subscribe to it. I use it at times. However, I would caution against making trading decisions based on what you see. Keep in mind that the market makers and institutions that run the show only allow you to see what they want you to see. First, not all orders appear in Level II data. Second, institutions place a lot of hidden orders, which limit our insight into true buying and selling pressure. Market makers have Level III access, which offers comprehensive visibility into all orders.
- Going All In: “Never go all in” is a common rule that many traders (particularly daytraders) live by. In fact, it is somewhat cliché. While I vehemently oppose pushing clichés, I do agree that new traders (and those who struggle with discipline) can make the mistake of getting too aggressive with particularly trades. Just as in gambling, there is no such thing as a “sure thing” in investing. You naturally want to invest in high-potential trades, but going all in limits your ability to navigate the treacherous waters if your boat capsizes. You have no ability to average down if the price moves against your trade. For instance, if you put all of your funds into a stock at $8 (long), and the price declines to $6, you are underwater until the stock retakes $8 or you add more cash to your account. Instead, let’s say you buy 1,000 shares of a stock at $8 ($8,000 cost-basis). The price declines to $6, and you invest another $8,000. This time, you get 1,333 shares. Your new average share cost is $6.86. Averaging down isn’t ideal. The ideal is to make a great entry the first time. However, a lot of traders into a quarter/half position as a failsafe against a bad trade, especially when less certain about the trade. Averaging down is not the same thing as continuing to pour money stock on a downward spiral.
Conclusions and Recommendations
Hopefully, you found this list of common trading mistakes helpful. Many traders create their own “code” or “rules” for trading to enhance their discipline. Do you have other suggestions? Any mistakes you have made that you would encourage others to avoid? Feel free to share in the Comments below!