1. Blowing stops-This one can get you into real trouble. Say you’re in at $24.5 and your stop is at $23.8. Things go well at first. Then the market opens down big and your stock opens below your stop. You tell yourself, “That’s ok. It’s a good stock. It’ll bounce right back after the opening selling pressure relieves.” But it doesn’t come back and creeps down the rest of the day. It’s at $23.5 now and you tell yourself to keep a mental stop at $23.3. If things are still sliding, you’ll get out there for sure. Then a competitor comes out with earnings below expectations. Bam! Your stock’s now $20.1 before you even had a chance to sell. “I’ll sell if it falls below twenty”, you tell yourself. It turns out the whole sector is having trouble not just the competitor. Your stock reports lousy earnings. Whoosh! You’re now at $17 and down 30%. Don’t laugh. Similar things happen all the time. If it hasn’t happened to you yet then you haven’t been trading long enough. Remember stops are there to protect your capital. When your capital runs out you are out of business. So no blowing stops!
2. Not having an exit plan before entry. Blowing your stops is bad enough, but I hear all too often about traders not even having an exit plan when they enter the trade. Trying to make the correct sell decision under the emotional stress of a tanking market is just too difficult. Besides, how can you evaluate the risk/reward of the trade without knowing your upside and downside exits? Also see risk/reward below. Write down where your exits are and why. That helps maintain discipline when the proverbial crap hits the fan.
3. Not evaluating the risk/reward. Along with blowing stops and not having an exit plan goes the trade risk/reward ratio. So you’ve established where you’ll take profits and set the stop loss. Time to make the trade, right? Not so fast. What’s the risk/reward ratio? If you don’t know, how can you be sure you should take the trade? Here is a quick example. The stock you want to buy is trading at say 40. You intend to take profits at 44 for a nice 10% gain. But there is no real support below 40 until 36 for a 10% loss. Sounds even right? Wrong. Most trading systems are only right about half the time. Throw in commissions and slippage and you’re now in the hole! It varies by the trading system, but a rule of thumb is to only take trades where the upside is AT LEAST 2.5 times the downside.
4. Not trading with the trend. I know there are all kinds of setups out there that are counter trend. But the fact is it’s a whole lot easier to trade with the trend. There is a lot of truth to the old Wall Street saying that the trend is your friend. I could tell you about a guy that used to short Google back in 2004 when the trend was up, up and away! Time and again he’d think it was over-extended and place the short just to be quickly stopped out. That’s a sure way to end your trading career early.
5. Position sizing. This is a rarely talked about subject, but every trader should have a good understanding of it. When you are first starting out you should limit your maximum loss per trade to ½% of your account size. Most seasoned veterans won’t go over 2%. The calculation goes like this. Say you have $20,000 in your account. Multiply $20,000 times ½% to get $100. That is your maximum allowable loss. Then figure your trade risk. Trade risk is simply your entry point minus your stop. Say your entry is 50 and your stop is 49. Trade risk it 1.00. Now divide the $100 by 1.00 to get 100 shares. That is the maximum number of shares to trade without risking more than ½% of your account. Most traders also like to limit their maximum trade size as a percent of account value. I have always used 20% for my account. Take the same $20,000 account and multiply by 20%. That gives you $4,000 which is the maximum amount of capital you should put in any single trade. Your position size for the same fifty dollar stock is $4,000 divided by $50 per share equals 80 shares. Notice that this is less than the shares used for ½% maximum loss per trade which was 100 shares. Always use the smaller number, in this case 80 shares. You can do this manually or write a little spreadsheet to do the calculations for you. If you are spreadsheet challenged, there is a trade tracker available here that has a separate position sizing tab that should be helpful.
6. Not using a trading log. Trading logs are useful in several ways. First it provides a convenient place to record your stops and targets. That scrap of paper you wrote your stop on today will be mysteriously missing tomorrow. Don’t let that happen and record this information formally. Also a trading log should have an area to record a code for the setup you used for entry. This allows you to review your trades by setup. There may be setups that just don’t seem to work for you. Avoid these or do further work to figure out why you have trouble with them. Most people find they do well and are most comfortable with only a handful of setups. You can take a look at the free trading log from #5 above, write your own, or there are commercial excel templates available for purchase online. Here is a commercial one I’ve used and can recommend.
7. Following tips. It’s all too easy to listen to some talking head on TV raving about some stock. There may even be a very compelling story behind it. The problem is because you didn’t do the work yourself you will not know when to get out. Besides, that great tip may just have been the tipsters attempt to bump the price up while they exit. As a famous TV personality says, tips are for waiters.
8. Not using limit orders. Especially on thinly traded stocks. The ask is 33.44 when you place your market order. You get your trade confirmation and it says 33.70! Some market maker just clipped you and is laughing all the way to the bank. Use limit orders and don’t give them that opportunity.
9. Taking profits too early. When I first started out I always wanted to sell as soon as I had a small profit. Maybe that was a deep seated fear of losing manifesting itself, I don’t know. But I do know I left a lot of profit on the table by selling WAY too early. If you’ve had a good run, go ahead and sell part of your position. No one ever went broke taking a profit. But don’t sell the whole thing for no reason. Give the rest a chance to blossom into a nice fat profit. No matter how good you are at picking stocks, you’ll never get a two, three, or even ten bagger if you sell at the first minor pullback.
10. Paper trading. Here’s what happens. You work on your trading skills tirelessly in your paper trading account. As you progress the profits start adding up very quickly. Emboldened by this paper success, the new trader starts placing large bets in his real money account. Things go ok at first, but then the losses start mounting. Before you know it huge losses force you to stop trading and try to figure out what went wrong. It’s not your system or the evil market makers screwing you. The fact is paper trading doesn’t have the emotional stress that comes when trading real money. This may be why mechanical systems that take the emotion out of trading often outperform discretionary traders. When it comes to trading experience there is no substitute for the real thing.
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