Today we are going to look at the common mistakes that even the smartest of people make when entering into trading. This will help to ensure that we avoid those mistakes on our path to becoming a successful trader.
One of the most common trading mistakes is sticking in a trade where you know you’re right in your analysis but the market continues to move against you. As the famous economist John Maynard Keynes once said “the markets can remain irrational longer than you can remain solvent”.
One of the best examples of the problem looks back to just before the millennium. Remember the tech bubble? Companies were earning ridiculous valuations, after having barely any trading history. You could see the market was inflated and massively overvalued. There were traders who shorted the technological markets in the run up to early 2000. However the market continued to move higher.
The problem comes from people’s expectations for growth because they can be way out of line with reality. There were many great traders at that time and began shorting before the peaks. You can see on the charts around that time, that the market continued to rise. So these traders must have had to maintain a huge account balance to stay solvent, before the market did eventually turn.
Were these traders wrong? No they weren’t because the market did eventually turn around and return back to rational levels. But many traders did not want to accept that the market was moving against them, and close their trades. Some of those traders are no longer around because they just couldn’t believe it. Perhaps they couldn’t suck it up and get out of the market and move on because they were so sure that they were right in their analysis. They were but the market will turn in its own time.
Stick to your trading plan, accept it when it’s not going your way.
the second biggest mistake that I see traders make comes from deviating from their strategy. They believe that by rigidly sticking to their rules, they are going to miss out of trading opportunities. So they alter their strategy to allow for additional market movements. The main part of this mistake is deciding not to use stop losses.
Here we have a DAX chart. showing horizontal resistance on the hourly time frame. A trader here would be looking for opportunities to sell a bounce. There were a few opportunities here. A trader will know that on occasions, the market [maker] will test previous highs or previous highs and take out stop losses, before moving in the original direction once more. For this reason, the trader decides to not miss the opportunity and let the trade run, free.
For the third and fourth circle, you can see that this strategy would have worked quite well, as the price respected that level. So when the fifth opportunity comes along, the trader shorts, with no stop loss. You can see how quickly the price runs away after spiking through resistance. So the trader spots the problem and decides to hold the position. Perhaps the market will turn back around and the trader can get some money back. Or even worse, perhaps they will open a second position to move the break even level. Sometimes the trader will get lucky, other times, the trader will go bust.