Investor's Most Common Mistakes
Common Mistakes of the Average Investor
We all want to make money and then more money. Because of this desire to increase our income we set out to create ways to earn money outside of our normal jobs. Because real estate investing or starting a business requires a lot more to get up and running many people turn to paper assets.
Stop and think about it for a moment. If you can just scalp $50 net a day out of the market you have picked up an extra $1,000 per month. Many stocks will move $1.00 to $3.00 within a days trading so you don't even have to be totally right, just catch the move and scalp some money.
Sounds easy right? But as you may have well experienced it is a lot easier to say then to do. Because this sounds to easy many have jumped in with their new idea and have been clobbered by the market.
Why isn't this as easy as it looks? Because the market is always right. This is a hard lesson to learn, but the market is never wrong. People are wrong. People will trust indicators to lead them when indicators are lagging. Markets can sometimes be confused, indecisive and even fickle, but the market is still right.
Because the market is always right then if we are going to take on the market we have to realize that our battle is not with the market. Our battle is with ourselves. I am going to list the common mistakes of the average investor, but one of the most important things that you can take away from this is how "you" need to train "you."
Common Mistake #1
Entering A Trade Without A Plan:
To be successful at trading the markets you don't have to be able to predict the markets. In all reality the markets are easy to predict because the only do three things. They go up, they go down, and they go sideways. Understanding this we can then focus on probabilities.
There are many strategies that operate on probabilities. When you watch their promo information they will tell you that when see "such and such" there is a 70% chance that the market will go up, down, or sideways. With this information you can trade their strategy and be right 70% of the time. You don't have to predict the market you just trade based on the probabilities.
Your plan will include different strategies for different market directions. You plan will tell you when you get in, when you get out, and how much profit you will take with you. Knowing this before you ever find a trade takes the emotions out of trading. Remember we are not trying to predict the market, we are not trading emotionally, we are going to trade based upon probabilities.
Common Mistake #2
Entering A Trade Without Understanding Your Risk:
How much are you will to risk on a trade? This is a question that too many don't ask themselves. Too often the average trader bets all they have on the "sure deal" only to loss what they have. Think of investing as a game. If you loose your money you can't play anymore. That's easy isn't it?
If you don't manage your risk you won't be in the game very long. The smaller your account the more careful you need to be regarding your risk. If you follow a trading plan and only take trades that have a profit potential of 2:1 or more and you make a decision to risk no more than 5% on any given trade then you can loose several times and still make money. I don't recommend risking 5% on any one trade. I would say that you shouldn't risk more than 3% on any trade and that your average loss should be less than 3% meaning that on some trades you only risked 1%-2%.
Bottom line is you have to know your exit point. You have to know what type of risk you are assuming and whether or not the reward is worth that risk. If you have not identified the maximum risk you are willing to take then you will trade emotionally and keep waiting for the position to turn back into your favor. Don't Do That! Cut your losses and move on to the next position.
Common Mistake #3
Breaking the rules of your plan:
Go ahead enter your justification now. "I know it is going to turn back around." "This is just a correction then it is really going to go my direction." Blah, blah, blah.
There is a reason we trade with a plan. We are trading probabilities. Not every position is going to work out because the market is always right and we aren't. Therefore, when we are wrong we cut our losses and move on to the next probable move.
I remember when I first started trading that I had purchased an individuals trading system. It was pretty easy to follow and wasn't full of a bunch of in-depth analysis. I wrote out my trading plan based on his strategy which included when I would enter, how large of a position I would take, when I would exit, and so forth. My first several traded (I think 13 or 15) were profitable. I was never in a trade for more that 7 trading days (average being about 3) and I was profiting from 5% to 75% on each trade. It was awesome until...
Well I am sure you know how the story goes. After that many winning trades I realized that I was a trading genius and that I didn't need a trading plan. I knew how to pick them. Needless to say my winning streak was over. Get a plan and stick to the plan even if you have 3, 4 or 10 losers in a row. In the long run the probabilities always pan out.
Common Mistake #4
Falling In Love with a Stock or Company:
When desiring to trade for profit you are going to look for the setups of your plan. It doesn't matter what the stock is. Don't fall in love with a company. All you are looking for is a positions. Many times the average investor will have a good day with a stock racking up a big gain. Now that is "their" stock.
You will do a couple of things when you get latched on to an individual company. First of all you will limit your potential gains. There are hundreds of companies out there that you can profit from. If you are stuck on one, two, or five companies you are missing a lot of opportunities. Getting hook into a favorite will also cause blindness. Of course I am not talking literal blindness, but you will become blind to bad news, earnings dates, and other pertinent information that will affect your position. Remember we don't trade emotionally so don't fall in love.
Common Mistake #5
Failure to Use or Stick with a Stop Loss:
Don't ever trade without a stop loss in place. I know that you know that your stock will only go up and that there is no way you can loose on this position, but don't do it anyway. All you need is for one of your stocks company to have a lawsuit filed against it or be ran by a "Martha Stewart" right before an indictment. You don't know what is happening behind the scenes therefore always trade protected.
Stop loss orders won't protect you against gaps, but they will limit your losses. If you are trading a company that is known for large gaps then you want to have a protective option as insurance, but the point here is always have protection that you will keep your risk and your predefined limit.
Common Mistake #6
Increasing Position Size to Make Up for Past Losses:
You should never go into a position willing to risk more than 3% on that individual trade. What the average investor does is when they have an expense trade they double up on the next one. They know this one will be profitable so they are not only going to make a profit they are going to recoup their prior loss. Again, Don't Do That!
Think about it for a moment. If you are trading a plan that has a 70% probability of being a profitable trade then you will, on average, win 70 times out of 100 trades. However, that also means that you will lose 30 out of 100 trades. What if you first 10 were loosing trades? If you doubled up on your second then you have lost an equivalent of three trades. Always remember that we trade based on probability. Therefore, get a plan and work your plan. In the end you will find that your plan worked for you.
Common Mistake #7
Failure to Learn From Past Mistakes:
Why did the trade not work? What could you have done different? Was there a way to reduce your losses when the trade started turning against you?
The average investor does not ask themselves these types of questions. They don't try to improve their ability to select positions. Your plan will cause you to target certain stocks based upon the strategy of your plan. But that doesn't mean that you will trade every stock that you target. Your selection process should get better over time, but it will only get better if you learn from your failures.
The best way to do this is journal your trades. From start to finish write down what you are doing and why. Keep really good notes. Obviously this is not mandatory, but any good trader will catalog what they are doing. That way they can go back and learn from their own trading history.
If you will take these 7 common mistakes and make sure you don't fall prey to them you will find that you actually can make a profit in the markets.