Emotion is the trader’s worst enemy
Counterintuitive as it may seem, most novice traders hold on to losses and let go of wins. Which, when you read it out loud, sounds ridiculous. Yet, several studies have shown that it is the most common mistake made by traders. So why would we do something so obviously unprofitable? At the heart of this isn’t some complicated technical impediment to reason. It is simply our humanity and the completely irrational but understandable fear of loss.
The principle is simple.
When we start winning, we get anxious about losing our gains. We close trades prematurely to capture the profit before the price starts to drop again. We should be holding on to it and closing out just as it turns, which would maximize the profit.
Conversely, when we start losing, we hold on to the losing position longer in the hope it will turn upwards at some point. We have the irrational belief that we will reduce or wipe out the loss.
This is the same principle that casinos exploit to keep unwitting patrons pulling at the one-arm bandits until their bank accounts are emptied.
So, even if we have more winning trades than losing ones, the average size of the wins versus the losses finds us in a net loss trading position over time.
It is the most basic and destructive mistake any trader can make as it spawns a host of further blunders that, if remain unchecked, can become habits that are hard to break. Here are 10 of the most common trading mistakes made by traders.
1. Unrealistic expectations
A common issue with new traders is how they define success as a forex trader. Many enter the field with the notion that they can make a quick buck and essentially win the lottery every day with a bit of luck. Trading is not gambling. It requires a key set of skills, discipline, analytic abilities, planning, and a long-term vision.
Temper your expectations and treat trading as a long-term endeavor and not a night out at your favorite casino.
2. Trading without a trading plan
Another critical trading mistake is assuming that skill and practice are enough. When we have no parameters against which to gauge the veracity of our trading choices, we run the risk of succumbing to our emotions without even knowing it.
A trading plan provides the necessary foundation on which to build a consistent growth path towards profitability and includes clear objectives, strong analysis, realistic expectations of profit (and losses), and reasonable time horizons, among others.
3. Failure to cut losses
Letting a losing position run in the hope of a turnaround runs the risk of wiping out both profits and capital. People often ask if day traders can use stop-loss orders to minimize losses when a position starts to trend downwards. The answer is yes. Limiting your losses through stops is a solid tactic and can help maximize the value of your wins over time, but remember, stop loss orders are not guaranteed to get executed so keep an eye on your trades.
4. Risking more than you can afford
Apart from minimizing losses and maximizing profits, many traders forget to manage the risk of wiping out their capital as well. Setting limits on how much capital you are prepared to risk at any given time is a useful strategy to stay trading and not find yourself in an overexposed position. While overexposure can maximize profits, it also amplifies losses and can signal the shift from trading to gambling.
5. Reward/risk ratios
Once you’ve set your limits and stops, it is important to understand your overall performance. In your trading plan, you need to set some goals against a set of metrics. One key trading mistake many traders make is not monitoring the average loss and profit per trade.
For example, if, on average, you lose $10 per losing trade and earn $15 profit per winning trade, then your reward/risk ratio is $15/$10 = 1.5. A ratio of 1 is break-even, while anything above 1 is considered profitable.
This ratio provides an indicator of your overall success as a trader and does not allow you to bask in the glory of big wins without assessing them against your losses.
6. Averaging down or adding to a losing position
This is a common mistake made by many day traders who sometimes use long trading positions to justify holding on to a short-term loss. The idea is that you buy more in a losing trend so that when the price “eventually” rises above your opening position, you will maximize your profits because you bought at a lower price.
As a day trader, you run the risk of the price never peaking above your original position before the close of the trading day, and you end up throwing good money after bad.
7. Leveraging too much
Leveraging, or the ability to borrow from a broker to make a much bigger trade, is very tempting, especially when a trader’s capital base is small.
The OANDA Trade platform supports trading with leverage, which means that you can enter into positions larger than your account balance and trade without depositing the full value of the position that you wish to open. One of the benefits of trading with leverage is that you could potentially generate large profits relative to the amount invested. On the other hand, trading with leverage could also result in significant, rapid losses to your capital. It is important that leveraging is done within the limits set in your trading plan to protect the capital base.
8. Trying to anticipate news events or trends
Once again, gamblers often try to anticipate a trend or news event and hedge on the potential outcome of that event. A typical example would be anticipating the announcement of a change in interest rates and hedging that an increase might trigger a short on a particular currency.
While economic fundamentals are important to understanding the long game, day trades are more vulnerable to other factors and require patience before acting, even after the news breaks.
9. Fear of missing out
The fear of missing out, or FOMO, on a big score is often triggered by a news event or a trending meme on social media. Once again, fear is the key motive and drives irrational decisions to trade even when it goes against any parameters and strategies you may have set out in your trading plan.
10. Too many trades too soon
Diversification of trades can be a good risk-mitigation tactic. However, diversifying too broadly and too quickly can lead to a number of pitfalls. Too many trades across a diverse portfolio in a short time frame can lead to information overload and silly mistakes.
Over-diversification can also lead to correlated trends that you may not pick up immediately. This simply means that you may believe you have mitigated risk only to find that your trades are linked, and you’ve achieved the opposite.
Practice makes perfect
The biggest mistake made by beginners of anything is to assume that it is easy to succeed. Trading is no different and, as with most endeavors, it takes skill and practice to perfect.
Skill can be learned. There are myriad resources available online for the beginner to garner knowledge and know-how. Whether you’re investing in crypto or forex trading, it is fairly easy to get going.
Practice is equally easy to access through an online demo. Start a practice account and simulate trades before you go live and risk your money. Apply for a demo here.
This article is for general information purposes only. It is not investment advice or a solution to buy or sell instruments. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk. Losses can exceed deposits. Past performance is not indicative of future results. While technical analysis is a well recognized study, other analysis, such as fundamental, may assert different views.
OANDA CORPORATION IS A MEMBER OF NFA AND IS SUBJECT TO THE NFA’S REGULATORY OVERSIGHT AND EXAMINATIONS. HOWEVER, YOU SHOULD BE AWARE THAT NFA DOES NOT HAVE REGULATORY OVERSIGHT AUTHORITY OVER UNDERLYING OR SPOT VIRTUAL CURRENCY PRODUCTS OR TRANSACTIONS OR VIRTUAL CURRENCY EXCHANGES, CUSTODIANS OR MARKETS.