Two main mistakes made by a trader and how to overcome them

Trading is a challenging career and it looks very difficult to master until you start consistently making money. There are lot of challenges faced by a trader whether its day trading or swing trading or positional trading. These challenges are both internal to the trader and external like market forces. These challenges and pressure forces the trader to make several mistakes.All these leads to 2 basic areas and they are entry and exit. No matter what a trader thinks or does, entry and the exit are the points where the rubber meets the road.

Past experiences , psychological impact of missed opportunities, greed, fear and hope leads trader to make following 2 critical mistakes :

1. Allowing position to go deep in red

2. Coming out of the profitable position before it hits the profit target.

First mistake will wipe out your profitable account very quickly and the second mistake will bleed your account slowly. If a trader makes both the mistakes then its catastrophic for his trading account.

Trader who is struggling may do both the above mentioned mistakes and he need to look into these aspects carefully before he restarts trading again. Even with a good trading strategy to start with he can wipe out his account.

Allowing position to go deep in red:

This is outcome of hoping that the position will come out of losses. Some of the explanation given by traders who are holding deep in red position are :

  • It has gone too low or too up and the stock will bounce back soon
  • Trader will quote some research report based on some fundamentals and justify holding the position

When the stock is going up or down consistently against your position, its better to book loss. Any contrary position should be based on some strategy and never on hope.

Now as a trader the position is always for short term and it is never based on fundamental data. Its better to invest based on fundamental research data , but never take a highly leveraged trading position based on such fundamental data.

Coming out of the profitable position before it hits the profit target.:

Usually such behaviour is seen when a trader has recently experienced a series of losses or he is not able to make money consistently from the market. Fear plays a crucial role here. Some of explanations (self or to others) given by traders making such mistake are:

  • Let me at-least have some profitable trades
  • Looks like market might reverse soon
  • Other traders he know are taking position in opposite direction
  • Worst is coming out of this profitable position to fulfill margin requirement of some deeply in red position. This is where the 2 mistakes mentioned get linked and will have a double negative impact on the account.

How to overcome these trading mistakes?

First step is to admit that we are making these mistakes and we need to correct them. Without this its difficult to rectify these mistakes.

We assume that the trader would have done his research to identify good entry and exit criteria which has decent win ratio and risk reward ratio. If you are a manual trader or discretionary trader with good trading strategy then focus on following points:

  • Follow strict stop loss and no matter what never change this during a trade. If at all if you feel that you are coming out of position too soon very often, analysis should be done outside market time and then any changes should be incorporated in later trading
  • Have a profit target based on your trading system and stick to it. As mentioned above any analysis or changes should be done outside market time
  • If you are discretionary trader who get in and out of positions very frequently then you can make use of Bracket Order which will help you to be more disciplined and also you have less things to track during trading.
  • Developing self discipline and control is very critical. Better to have an hobby outside stock market.

The strategy which I personally favour is the following one:

As a trader its better to focus more on trading strategy and play around with risk/reward ratios, win%, maximum draw-down and equity curves to come up with a plan that suites your style of trading and personality. But after this its better to automate or semi automate your trading strategy, where the automated system will identify entries and exit and no emotion comes to play. If you are still not making money, you can tweak different parameters, backtest them and then modify your system until you have a profitable system.

So for manual traders strict self discipline and following profit target & stop loss is important. If overcoming emotions is difficult but you are confident on your trading system then better to automate your successful trading system.

If you find difficult to follow these points then its better to take a break from trading and reconsider in later point of time when you are ready.

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