Stock trading is one of the most competitive jobs on the planet with only a 2% success rate. Remaining 98% of the people who attempt stock trading end up losing money in the long run. In the competitive world of trading which has such a low success rate, even small mistakes can make the difference between being a profitable trader & losing all your hard earned money. Here are the 16 biggest mistakes which stock traders make –
1. Expectations of earnings from Day 1
This is very common amongst new retail traders. Everyone wants to earn money from the very day that they start trading! A doctor or an engineer takes years of hard work to become successful and earn money. But for some reason people think that being a stock trader doesn’t require any skills. And they couldn’t be more wrong. In a game where 98% people fail, the level of skill required is extremely high because you WILL always have to fight to win money. This is a dog eat dog world, so an unprepared trader will lose everything sooner or later.
It is extremely important to study technical analysis before even attempting stock trading. Most new traders who do not have a good understanding of stock trading turn to other people’s advice or news channel recommendations to start their trading career. Unless you are trading with an experienced trader, chances are that you will end up losing money. Leaving your hard earned money in trades which you have just heard on the news or heard your colleague whispering is just like leaving your doors open. Chances are that you will get robbed! Make sure that you are well prepared before even attempting to trade.
2. Trading based on news (or worse, feelings)
This is one of the best ways to lose money in the stock market. Stock trading is a business which is based purely on technical analysis which involves the analysis of stock charts. There are clear buy and sell patterns based on probability which professional traders use to take trades and consistently make money. But when most new traders start their trading journey, they think that catching the news and acting accordingly is professional trading! Trading based on news will never make any money for you in the long run because everyone is watching the same news and you are not the first one to get it! To read more about this, visit this article – Should you trade based on news or charts?
The only thing worse than trading based on news is trading based on ‘feelings’. Many amateur traders track the stock for a few days and then get a feeling that the stock will go up or down. This is the same feeling which you get when you buy a lottery ticket hoping that the lucky number will show up. Stock market doesn’t care about your feelings! The ONLY way to trade is to religiously follow stock charts.
3. Trying to make a profit in every trade
Understanding the trading philosophy is extremely important to become a successful stock trader. A trader doesn’t want to make money in every trade! In fact, nobody on Earth can make money in every single trade. The objective of trading is simple – lose less money in bad trades and win big in good trades.
Think about it. If you make a profit of Rs. 1000 in 5 trades and you make a loss of Rs. 500 in 5 trades, then you have made an overall profit of Rs. 2500! It might seem counter-intuitive, but the ability to take small losses is one of the most important skills in stock trading. Everyone knows how to make a profit but very few people know how to take a calculated loss. Those few people are successful stock traders!
4. Trading without using a stop-loss
New traders are always afraid of stop-loss because nobody wants to make a loss! But like I have mentioned, everyone knows how to make a profit but only professional traders know how to take a calculated loss. A stop-loss is a predetermined loss which a trader is ready to take in case the trade doesn’t go as planned. Do trades sometimes backfire? Yes and many more times than you think! Even the best traders have an accuracy of around 60-65% which is incredibly high. So there will be many instances where the trades will go wrong and stop-loss will be hit. As a trader, your only goal is to GET OUT as soon as your stop-loss is hit. In fact my recommendation would be to automate your stop-loss and use a GTT (good till triggered) order to avoid any emotions involved during trading. There are many stock brokers (such as Zerodha) who have a GTT (Good till triggered) feature which will automatically square off the trading position if a target and/or stop-loss is hit. If you would like to open a new demat account with Zerodha, visit this link.
The worst thing which you can do when you see a stock approaching the stop-loss is to reduce your stop-loss value to avoid hitting it. It is okay to take a small loss in a bad trade than lose a huge amount of your capital! Always use stop-loss religiously. If you want to know more about stop-loss, visit this article.
5. Poor money management
Always divide your capital into 25 (or more) equal portions to take up any trading position. Do not put more than 1/25th of your entire capital in any particular trade regardless of how sure you are about the trade. Trading always has a possibility of backfiring (which is why we use stop-loss), so heavy positions in a single trade is a big NO! Many trading accounts get demolished just because their last 5 trades ended up hitting the stop-loss. Continuous losses in a row is actually very common in trading especially in a choppy market. Those bad trades end up hurting the most when those trading positions are too big for the trader to handle. Money management is crucial in stock trading because without it, even a few bad trades can spell doom for your entire trading account. Taking positions into multiple trades with a small portion of your total capital will ensure that even with a 50-55% success rate in trading, you are consistently making profits!
6. No preparation before the trading day
A professional trader doesn’t decide which stock is providing a good trading opportunity on the trading day itself! The preparation phase is before the trading day. Always use your evenings or weekends (outside trading hours) to prepare for the trading day. This will involve screening of stock to figure out exactly which stocks are providing a good trading opportunity. Only these stocks need to be in your trading watchlist. Most amateur traders do not have any preparation before the trading and then end up buying any particular stock which “looks” good that day. Going into a battle without a plan is a losing battle. And trading stocks is a new battle everyday!
7. No exit strategy before entering a trade
Going into a trade headfirst and later figuring out about the exit strategy is a sign of a complete amateur in trading. You need to know exactly about the stop-loss and target at which you will exit the trade even before you have entered the trade. This is why the preparation phase is key for professional trading. The stock selection is decided before the trading day and the exit strategy (stop-loss and target) is decided before entering a trade. Since the exit is already decided, this removes any emotions which overwhelm the trader and makes him/her take bad decisions. When the exit is already decided, this will actually make it clear to the trader whether he/she wants to even take the trade or not based on the reward-risk ratio and that brings us to the next big mistake.
8. Choosing stock with bad reward-risk ratio
This is very common amongst new traders. They may choose everything correctly – their stop-loss is on point, trading position is small & they always trade purely based on technical analysis but a bad reward-risk ratio can ruin everything. Many new traders are willing to risk Rs. 1000 in order to earn Rs. 100. To become a profitable trader with such a reward-risk ratio, you will need to have more than 10 good trades for every bad trade which is practically impossible even for the most skilled traders.
Always choose a minimum of 2:1 reward-risk ratio before entering a trade. This will allow you to make consistent profit even if only 50-55% of your trades hit the target which is a common hit rate amongst traders. But what if the stock chart allows only a 1:1 reward-risk ratio? Then do not enter that trade! A trader’s skill is not limited to buying and selling stocks, but also requires a complete understanding of whether to enter the trade or ignore it. In short, never risk your capital unless you are expecting a handsome reward from the trade.
9. Trading against the trend
There is an old saying in trading – Trend is your friend. This saying makes a lot of sense because a clear trend improves the accuracy of your trades. The meaning of trend in a nutshell, is a clear direction in which the stock movement is taking place. Look at the following two charts which are shown in a 1 hour time-frame (every single candle represents 1 hour) –
This stock chart clearly shows that the stock is in a down-trend. What that means is that if you were to buy this stock, there is a high possibility that the stock price will move lower in the future. The trend shows a clear downward movement.
This stock chart clearly shows that the stock is in an up-trend. What that means is that if you were to buy this stock, there is a high possibility that the stock price will move higher in the future. The trend shows a clear upward movement.
The only way for a trader to lose money when trading alongside a trend is when the trend reverses. But many retail traders go the opposite route. They take the trades which are in the opposite direction of the trend. Shorting an up-trend stock and hoping that the stock will reverse is a fool’s game. Same thing applied for going long on a down-trend stock. Always go with the flow! If a stock is going up, focus more on long trades and if a stock is going down, focus more on short trades. Entering a trade in the wrong direction and hoping that the stock will change it’s trend will significantly reduce your probability of success in stock trading.
10. Overtrading in a choppy market
Trend is your friend but a choppy market is definitely NOT your friend. Choppy markets refer to the behaviour of the market when there is uncertainty and a clear trend is not available. The following stock shows us a clear example of a choppy stock –
It is very difficult to predict whether this stock will go up or down in price because there is currently no trend in the stock. A trader needs to understand market conditions and act accordingly. In a choppy market, it makes a lot of sense to reduce the number of trades because there is a lot of uncertainty and the chances of hitting the stop-loss increases significantly. Sometimes you have to play slow like a Test match instead of going for boundaries on every single ball to protect your wicket. The exact same thing applies to trading where you need to take fewer trades in a choppy market to protect your capital!
11. Afraid to re-enter a stock after hitting the stop-loss
Unlike investment, there are no good or bad stocks when it comes to trading. Trading is all about identifying stocks which are providing good trading opportunities and capitalizing on it. So if there is a company which you traded but ended up losing money, do not blacklist that company. Many new traders get scared when their stop-loss is hit & they blacklist that particular stock to be a “bad” stock which makes them lose money. Stock trading is a business and there is no need for emotional attachments with the stocks which you are trading.
If a stock is providing a good opportunity to trade then regardless of the past history or your experience with the stock, you should take that trade. Even if the same stock has triggered your stop-loss previously, there is no need to be afraid of that stock as long as your analysis is on point. Purely follow technical analysis for stock trading.
12. Trying to ‘recover’ lost money
Some traders go the opposite way and instead of being afraid of the stock, they become obsessed with it. The whole idea of recovering my money from the same stock is a very bad idea in the world of trading. Every single trade is separate and should be taken purely based on your stock analysis. It doesn’t matter if the stock has given you losses in the past, there is no point in getting emotional and trying to ‘recover’ your lost money.
There is nothing special in making money from the same stock in which you lost previously. Money is simply money, regardless of which stock you trade to make it. In trading, emotions need to be completely separated from your strategy. So, don’t focus on taking revenge on any stock. Choose stocks for trading solely based on your stock analysis.
13. Not tracking trading performance
Traders do not like to do this because this is not fun. Nobody likes to track their trades! But tracking your money is an important part of stock trading. Just like any business, there needs to be a clear balance sheet which will tell important things such as the capital in hand, capital currently blocked in trades, profits, losses, etc. This is key for any business to succeed and just like any other business, it is required in stock trading.
Another reason to track your performance is to back-test your strategies. Traders generally have multiple strategies which they test over years and finally settle for a few strategies which have proven to be successful. In order to assess the performance of your strategies, you NEED to track your trades. Trading just for the sake of trading and later realizing that you are continuously losing money in the business is an amateur way to trade. Test all your strategies and only stick with the most profitable ones.
14. Not having enough patience (yes, patience is needed even in trading)
It is generally assumed that patience is required only for stock market investors. Traders don’t need patience because they are buying and selling stocks so frequently. WRONG! Unless your trades last a few seconds, patience is key for stock traders as well. Many traders take a swing trade for a few days/weeks and get frustrated after 5 minutes when their stock has not moved. The stock market works in it’s own way and doesn’t really care if a trader has taken a position in the stock market! The trader needs to blend as per the rules of the stock market and not the other way around.
Sometimes traders do everything right until the waiting game. The trader could have screened the stock perfectly, decided the stop-loss and target based on technical analysis, analyzed the reward-risk ratio and entered the trade in a professional manner. Then it’s all about patience. Patience for stock to move and not getting frustrated due to the waiting time is a very important skill for a trader to learn.
15. F&O trading without much understanding
Futures and options are derivatives which are traded in the stock market. If you don’t know what options are, visit this article. Futures and options are financial derivatives which are reliant on stocks but are not actual assets. Simply put, these are contracts which can be traded in the stock market and they expire on a certain date unlike stocks which do not have any expiry date (unless delisted). New traders are attracted especially towards options trading because it has a much higher volatility when compared to trading stocks. There is nothing wrong with trading futures and options and many successful traders do this to make consistent profits in the stock market.
However, F&O trading is much more brutal for new traders. There is a much higher chance of making mistakes when trading F&O as compared to trading stocks. Sometimes even a small swing of 0.5-1% in a stock is enough to cause a wild swing of 10-15% in the options for that stock. New traders need to be very cautious when trading F&O and in fact my recommendation would be to stay away from this trading unless you are extremely comfortable with trading stocks. Before trading F&O make sure you have the correct knowledge on how these financial contracts work because unlike stocks, these contracts expire and are squared off on the day of the expiry!
16. Worrying about missing a golden opportunity
There is no such thing as a golden opportunity when it comes to stock trading. Every month there will be lots of opportunities to trade stocks which will entirely depend on the trader’s skill to identify them and enter the trade. Sometimes a trader is unable to take a trade due to many reasons – no capital left to enter the trade, servers are down for the demat account, busy with some other work, etc. If you later find out that you would have succeeded by taking that trade, there is absolutely no reason to regret it. There is no reason to think that a golden opportunity has slipped from your hand. There will be many more opportunities which the stock market will keep on providing in the future. Only focus on what is currently in your hand, not on what could’ve happened!
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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Solid trading advice
I’ll say 16 steps to a profitable trading plan
Thank you!
Thanks for good guidance
Request some advice for long term investors also
Thanks!
More content for long term investors will be added soon.