Ask an experienced trader about mistakes she’s made in the market, and she’ll probably be able to point to a bunch of them and to the scars that help her remember how to avoid them in the future. There’s the improvisation approach – a trader who hears an idea from a financial commentator on TV and decides to buy on impulse. Big mistake. Traders need a strategy and a plan.
Bottom fishing is another common trading mistake. The problem with investing in assets that look like they are at rock-bottom and can’t go cheaper, is that they often do go cheaper, or hover at a low point for a long, long time. Another trading trap is falling in love with your asset. No matter how smart the CEO of the company whose stock you hold, or how glittery that gold, successful traders know when they hit their stop, or designated selling point, it’s time to sell.
The single most important mistake that leads traders to lose money starts with psychology.
Vonetta Logan, a trader, host of tastytrade’s dailydose and Second City trained comedian known for her satirical view of the news affecting the financial space looks at why human psychology can make it tough to navigate markets. She talks about how we are our own worst enemies. We all know financial markets are dominated by uncertainty and risk. We also know that the mostcommon mistakes traders make have to do with poor risk management strategies.
Traders are often correct on the direction of a market. The problem lies is in how much profit is made when they are right versus how much they lose when wrong. In other words, traders tend to make less on winning trades than they lose on losing trades.
The core concept is simple yet profound: most people make economic decisions not on expected utility but on their attitudes towards winning and losing. That negative feeling you experience from a $500 loss can be substantially more than the positive feeling you experience from a $500 gain. Simply put, we take more pain from loss than pleasure from gain.
In practice, you need to find a way to straighten that utility curve—treat equivalent gains and losses as offsetting and thus become purely rational decision-makers.
In general, there are three tips traders should understand to increase their chances of success.
1. Get comfortable with the face that losing is a part of trading.
2. Set stop loss and limits to define your risk ahead of time.
3. Aim to achieve proper risk reward ratios when planning out trades.
Learn more by downloading our guide, Traits of Successful Traders.
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.