In life, following directions is half the battle. When trading, avoiding the top mistakes is equally as important.
I recently spoke with top StockTwits traders Joe Donahue (UpsideTrader) and Joey Fundora (DowntownTrader) to learn what they believe are the top three mistakes new traders must avoid. I think you will benefit greatly from their advice. Let’s start uptown, then take the A-C-E subway downtown …
Joe Donahue (UpsideTrader): Top Three Mistakes New Traders Must Avoid
1) Not Selling Fast When You Are Wrong. What I can lose on a given trade is always more important to me than what I can make. Most new traders will make a purchase or initiate a short position, but when the trade turns against them, they immediately forget why they bought or shorted the stock. As a result, they will let “hope” take over as their new strategy. Hope is not a strategy! Wall Street is littered with traders, hedge fund managers, and investors who begged to differ on that fact. If you are looking for evidence, just look at GM, AIG, or Citigroup. These are longer term examples, but the same holds true for day trading. Take your medicine and accept defeat when you are on the wrong side of a trade. Great traders have tough skin and move on.
The solution for this problem is to use stops. I always use stops when I trade. The percentage you are willing to lose will be a direct byproduct of your own risk tolerance — but use them always. I use approximately a 2% stop on all my trades (sometimes less). I sleep at night and usually make money.
2) Using Multiple Approaches or Strategies. Many new traders think they have a strategy … until they don’t. They feel they are comfortable with an approach, but at the first sign of failure they stray. Thus, they become aimless and reckless. Before they know it they are trading rumors, chasing stocks, and ultimately blowing up their account (before they have any real success at all).
New traders will “over trade” or do what I call “revenge” trading right after a loser. Revenge doesn’t work in the market and the only person that benefits from over trading is your broker. I have one strategy I use. Is it the only strategy that works? Definitely not. As a matter of fact almost every trader I know uses their own approach. Some strategies are proprietary systems. Some are plain vanilla strategies that are very basic in nature. The point is have a plan and an approach! So, learn one thing and be the best at it. There is way too much “noise” out there in the new and old media. Everyone claims to be a bull or bear market genius. Put the media on mute so you can follow and perfect your plan.
Being a voracious learner is absolutely key. Be a sponge and learn as much as you can. If you are a day trader, use the websites and read the books that will help you become the best. There are some phenomenal trading blogs out there. Most information is a click away.
3) Trading Too Large. I ran a sizable hedge fund and thankfully always beat the indices in good or bad markets. Much of my initiation and experience was baptism by fire. But if a novice trader asked me the one thing he or she should do to get a feel for the market, I would tell them to paper trade or use very small dollar amounts. There is absolutely no substitute for “screen hours.” Tiger Woods hits five hundred to a thousand balls a day, and he is already the best in the world. If trading is truly your passion, then be in front of your trading screen all day. If I miss twenty minutes of trading because I am out of the office, I genuinely feel like I missed the whole day — my rhythm is gone and my edge becomes diminished. You may be able to get away with less screen time if you are a longer term investor. But if your passion is perfecting the short term trading game, you won’t stand a chance. Good luck out there and don’t listen to the pundits.
1) Not having a defined trading strategy. To consistently make money in the markets, a trader must have an edge that can be repeatedly exploited. Many traders don’t understand what this really means. Instead, they hop around from one trade to the next relying solely on intuition. While a trader can have periods of success trading without a plan, in the long run it would be extremely difficult to maintain any level of success without a repeatable core strategy.
I remember attending a trading conference with my brother and a friend. During one of the breaks chatted with some other traders. We discussed Investors Business Daily and the IBD100 when another trader walked up. The trader asked a few questions about the types of traders we were and how we scanned for stocks. When we returned the question, he mentioned he was a momentum trader and loved trading stocks in the IBD 100. When asked about his strategy, his exact words were “you know, I just look at something that looks good, and just try to get on and see what happens. Once I’m in I try to make a little and then see where it goes. Of course sometimes you get caught and you have to wait it out till it comes back.” That was the extent of his strategy. Of course this is an extreme, but there are many traders who mistakenly believe they have a well defined strategy.
In reality, the most common mistake is there are many traders who have a perfectly acceptable strategy, but consistently find themselves straying from it in order to chase what is hot in the markets. It’s not enough to have a strategy — a trader must refrain from getting away from it when tempted by greed. There are thousands of trading strategies that will work consistently, but all of them will fail without the discipline to stick to them. Trading is more about discipline and consistency, and less about fancy trading systems. A trader will usually be successful so long as they have a method to cut their losses quickly and maximize their profits on winning trades.
2) Ignorance of time frame. This mistake can probably be rolled up into Mistake #1, but is important enough to mention on its own. Knowing your time frame goes beyond what time frame charts you look at for trading. The first thing a trader needs to know is what they are trying to accomplish with a trade. While making money is the obvious answer, I’m talking about determining what move a trader is trying to capture. Often, a trader focuses his entire attention on getting into a trade. He or she has little regard for how they will get out of the trade. This usually leads to wavering back and forth on when to exit. Traders need to know how long they will be in a trade and what they are trying to accomplish. Otherwise, the markets dictate how they will exit. Traders need to define what part of a trend they are trying to capture, then act accordingly. While the signals don’t have to be defined to the point of being mechanical, traders should have a clear and definite direction they are taking in a trade.
There are several different trading styles out there — from scalping a tick chart, to position trading off weekly charts. For instance, if you are trading to capture a several day trend, then your target and stop loss should complement that objective. I often see traders say they are trying to capture a multi-day move. They leave an open-ended target, then panic on an intraday pullback. While there is nothing wrong with leaving an open-ended target, traders need to be willing to suffer through a pullback if they are trying to let a trend run its course.
Too often, I see traders entering trades with no real ultimate target and no clear understanding of how to identify when they are wrong in the trade. Stop losses are intimately tied to targets, yet this is an area which confuses many traders. Many traders also mix up their time frames once they are in a trade. Basically, if you’re going to scalp, then scalp and scale or get out on strength. Don’t worry about missing a continuation move that falls out of your time frame. First of all, this wasn’t your planned trade. Second, as humans we tend to have a selective memory. We tend to discard the myriad of times when holding would have been unsuccessful. If you are a trend follower position trading, it makes more sense to trad without a target and keep a very loose trailing stop. Otherwise you will not allow the trend to unfold. Many traders don’t realize their objective, then set incompatible exit orders. While traders don’t need to lock themselves down to a specific time frame, every trade setup in their arsenal should attempt to capture a well defined movement.
3) Thinking about what is supposed to happen instead of focusing on what is happening. Recently, I’ve seen traders fighting the tape on the entire rally off the March lows. I’ve seen very smart individuals going to cash because they can’t see how this rally can be for real with the economic picture so bleak. Many traders are crying foul, saying the government is manipulating this or that, fudging employment data, economic reports, etc. I don’t know if any if that is true, and I don’t really care. I’m not a naïve person. I understand there is a certain amount of manipulation and unfair trading practices that exist. However, I also believe that this behavior is prevalent in any industry/activity where large amounts of money is involved. Greed is one of the most powerful emotions we have as humans — probably rooted deeply in our survival instincts. There will always be corruption and manipulation in the financial markets. However, this should not stand in the way of any trader stepping in and making money. It’s okay to feel however you want, but in the markets only price pays. The old Jesse Livermore quote says it perfectly: “There is only one side to the stock market; not the bull side or the bear side, but the right side.”
Traders should learn to focus on what is occurring in the markets and try to remain objective. While there is nothing wrong with using your intuition and intelligence to uncover possible themes or trading scenarios, traders should also remain objective and let the markets either agree or disagree with their thesis. It makes no sense to throw up your hands and let the markets run you over because they disagree with your beliefs.
In summary, the cure for most trading mistakes is to have a plan for dealing with whatever the markets throw your way. Once you have a plan you will not react to the markets. Instead you will proactively trade a well thought out plan.
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