Trading has never been as popular as it is today.
It probably feels a lot like the dotcom bubble for those who went through that, with random folks talking about their stock picks in coffee shops, waiters giving you trading advice, etc.
Traders are flocking to Reddit forums like WallStreetBets for trading strategies and advice, being pulled in by the allure of grand slam gains with relative ease. But the vast majority of these traders are left with a blown up trading account and a bunch of questions.
The reality is that trading is difficult. The concepts are simple enough, but they’re not easy to implement.
This is the key fact that contributes to why new traders struggle when they’re first starting out.
In this article, we’ll go over some key mistakes that we see new traders making consistently, and how you can counteract them.
Aiming for Home Runs
Most new traders chase massive, 100%+ gains on each trade, aiming to get rich off one good idea. While there’s countless examples of folks striking it rich from one trade on subreddits like WallStreetBets, what you don’t see is the 1000 others for every one of those stories of the empty brokerage accounts of traders who tried to hit the same home runs and failed.
The stock market is pretty efficient. Many of the smartest people in the world spend all of their waking hours studying and solving problems related to markets, and almost none of them have found consistent methods of achieving massive, 100% gains on each trade.
If you look around at most of the best traders, their trading is far less glamorous than their lifestyle. They hit singles and doubles all day. They build up a bunch of small wins which outnumber their small losses and slowly build their accounts.
Sure, they hit some home runs along the way, but those come as a result of showing up everyday and taking those small profits rather than trying to turn everything into a home run. If they tried to hit a home run every time, they would have gone broke before they ever hit one.
Taking Advice and “Hot Tips”
If you’ve been trading for some time, people will frequently ask you about some trendy stock and if they should buy it for reasons XYZ.
New traders are subject to tips from everywhere. From social settings like bars and college dining halls, to subreddits and Tweets.
One of the key separators between traders with a good potential of being successful is that they adopt a sound strategy that has some semblance of consistency. They roughly know what to expect in terms of returns over a large number of trades.
When you adopt a strategy, you find that the outcome of any individual trade doesn’t matter much. Instead, the performance of the entire strategy when viewed in the context of several trades is what should be under scrutiny.
There’s so much randomness in the market that you can’t get too attached to specific outcomes, and instead view your trades like you’re counting cards in blackjack: you know that you have an edge over the house, but the dealers are still going to hit blackjack several times.
On the other hand, following a hot trading tip is like being at the blackjack and making the bets that the drunks behind you call out. Even if what they tell you is correct, it doesn’t exist within the context of an overarching strategy, so your results will be inconsistent, unpredictable, and very likely, unprofitable.
For example, let’s say you devised a trading strategy based on moving averages. You want to buy the stock when the 10-day moving average crosses above the 20-day moving average, and close the trade when the 10-day crosses below the 20-day.
Perhaps you do some testing on historical data and you can see that historically, this trade is profitable 55% of the time, and the profits on your average winning trade are 1.3x that of your average losing trade.
With this knowledge, you won’t be let down when a trade goes wrong. You know that it’s going to happen roughly half the time and it’s simply a part of being disciplined in trading a strategy.
On the other hand, when you get a tip, you have no idea where that trade fits into the tipper’s strategy, or if they have one at all.
Falling In Love With a Position
Good trading is unemotional.
Good traders are unswayed by hyped up stories about a stock’s future potential. They instead look at the price and ask “does the rest of the market agree with this?” Or maybe they ask “what is the likelihood of this bullish event occurring, and if it does, can I quantify its likely influence on the stock price?”
There’s endless stories of traders finding a penny stock that claims that they’re weeks away from striking gold, getting a huge contract with Amazon, or getting FDA approval on a cancer drug.
The traders get so wrapped up in the story, that even when all of the evidence points against their wishes being reality, they double down and buy more of the stock, even after it’s gone down in a straight line for months.
The best way to avoid falling victim to this common trading mistake is to be a skeptic. Whenever you hear someone tell you that stock XYZ is going to the moon, do your own research.
Figure out the outcome required for the stock to reach that specific price. What does the company need to achieve? Is there a history of companies in their position doing so, and what is special about the management of this company that they’d be more equipped than the rest of the market to strike it rich?
Further on that point, you need to let your trades go when they want to leave. This means having concrete rules for when you close trades.
It can be something simple like a percentage drawdown from your entry point, or you could choose to exit the trade when a technical indicator reaches a certain value. Whatever it is, you have to stick to it religiously. You can’t become a mark, being the person that thinks the WWE is real and that the Undertaker really buried Kane alive.
This is very hard in the beginning, but after you’ve traded for a while, you’ll see that most of these hyped up stories do not pan out.
Lack of Education
The internet is a treasure trove of information, free and low-cost, that is constantly at your fingertips. If you can check the box scores for sports constantly, don’t you think that you should give the same (or more) respect to the hard-earned money that you’re putting at risk every time you put on a trade?
You can read through this article and understand that you shouldn’t try to constantly hit home runs, take trading tips, or fall in love with your positions.
That’s a good start, but if you don’t know how to actually trade profitably, you’ll still go broke trading. And to learn to trade profitably, you need to actually learn about the financial markets.
Learn about the well-known, well-established strategies that exist and how you can take ideas from the ones that appeal to your temperament and develop your own strategy.
No matter how much you learn or watch out for classic trading mistakes, you’re still likely to struggle at some point early on in your trading career. The market has a funny way of knocking you down when you’re doing your best.