Trading can be a useful way to make ends meet, especially in these trying times. However, with the big potential rewards from trading also come big risks, and one mistake can result in pretty significant losses if you don’t know what you’re doing. Here are some common mistakes that you should consider when taking your first steps into the world of trading.
Trading without a plan
This might seem like a no-brainer, but planning should be an essential part of your trading operations, and committing to a solid plan can help prevent your emotions getting in the way of trading success. An effective trading plan should outline how, what and when you should trade, and should be informed by extensive research into your chosen sectors, markets and financial instruments.
You should make extensive use of spreadsheets and online resources to analyse markets and document your trading activity, so you can effectively spot patterns, assess risks and refine your trading process- a trading journal can be a useful tool to help you develop and consolidate a trading plan.
Trading without research
The best laid plans of mice and men are nothing without adequate research, and it’s essential that you know as much as possible about the world of trading before you take the plunge and start trading yourself.
You should do your homework about your chosen markets, sectors and trading types- make sure you understand the different financial pressures for each trading style, and use your research to inform your trading plans. You can also use demo accounts or simulators to test your trading plans in a safe environment, which can be useful for identifying your strengths and weaknesses, as well as any gaps in your trading plans or factors in your chosen markets you hadn’t considered.
Trading without money management
In a similar vein, managing your money might seem like an obvious thing to consider with trading but an effective money management plan is an important part of maximising profit and minimising loss.
A thorough money management process can help you formulate defensive strategies to preserve your capital and maintain profits, saves you from draining your account when you experience a series of losing trades and could prevent you from overextending yourself and overestimating your profits when you are doing well.
There are a number of different money management techniques you can employ to make sure you stay on top of your trades- these include setting up stop loss and take profit orders to help save you from risky situations, as well as organising your trading process through spreadsheets and diaries.
Risking too much on one trade
It might seem tempting to put all your eggs in one basket and put a lot of money behind a trade you have high hopes for, but being reckless with your investments could put you at the mercy of volatile markets and result in big losses if it turns out your faith is misplaced.
Money management techniques can be a useful way of making sure this doesn’t happen, and making use of the 1 percent risk rule can also help rein in your investments to ensure that if you lose on a trade, you don’t lose big.
Not cutting your losses
Knowing the right time to invest is an important part of trading, but just as essential is knowing when to bail. Sticking to your guns on a poor trade might seem like the right way to justify your investment, but that’s just the sunk cost fallacy talking- there’s nothing wrong with abandoning a sinking ship, and it’s in your best interests that you don’t drown.
One thing that can help you cut your losses and get away from a bad trade sooner is setting up a stop-loss on your trades, which allows you to buy or sell a specific stock once it reaches a certain price. You can read more about the details of stop-losses here, and you can find out how to use stop-losses in conjunction with the 1 percent risk rule to help manage your investments here.
Acting on impulse
Psychology can have a surprisingly powerful influence over your success as a trader. Emotional responses can even undo all the good work you’ve put into studying the markets and planning your strategies – so it’s important to know how to stop this happening.
Setting up a trading diary and documenting your impulses when you make a trade will help you to recognise when your feelings are getting in your way, impairing your judgement or driving you to trade in a way you shouldn’t. You can read more about the psychology of trading, as well as the various emotions that could affect your trading, here.