Every beginner is attracted to trading because he or she thinks that trading is an easy way to make a lot of money. Later, they all find out that trading profitably and consistently is way more complex than they thought. In trading, as in any endeavor, preparation is key to success.
Learning how to trade profitably and consistently is absolutely doable. In fact, there are a lot of professional traders that earn income year after year. But there’s a catch. Every trading strategy experiences periods of drawdowns. And traders need to be prepared accordingly.
Trading is a journey. In case you are a beginner trader, you can learn from your own mistakes and lose a lot of money on the way. Or you can learn from other people’s mistakes, save money, time and increase your chances of success. Today, we’ll discuss the main pitfalls to avoid when trading financial markets.
Having wrong expectations
There are various reasons why traders lose money. And one of the reasons for traders to lose money is having the wrong approach to trading. In case you think that it’s possible to double your investments overnight, most likely, you will take great risks and endanger your whole account. Making money in the markets is dependent on various factors. The more funds you can allocate, doubling the money will be more difficult. Technically, doubling a 100 USD and 100 000 USD requires the same amount of work, but in reality, it’s much more difficult to manage the 100,000 USD. The reason is simple, it’s way easier to risk 20% of your account when your trading balance is only 100 USD.
Proper approach to trading includes:
- Plan to double your investment not in a week or months, but in years. It’s much better to be consistent and show that you can earn money to investors than to take huge risks and blow up accounts.
- Think of trading in terms of percentage points and not in sheer numbers. As mentioned above from the 100 USD and 100,000 USD example, one of the main difficulties in trading is the ability to manage large sums of money.
- Think of trading as running a business and not as a source of stable income. No matter which strategy you choose, every strategy experiences temporary or permanent drawdowns. Successful traders manage to limit their losses during temporary drawdown periods. They achieve this by lowering trading size or by going demo until they build back confidence in their strategy. There are occasions when trading systems stop working permanently. Often the main reason is the change in market conditions. Every trader needs to be prepared for drawdowns by having funds saved for everyday expenses. Having emergency funds is critical for healthy investing. Your ability to pay your bills should not be dependent on your active orders, as this will make you greedy and force you to overtrade.
Trading without a deep understanding of the markets you are trading
Every financial market is different. And every particular asset in an asset class is also very different from the rest. For example, GBP/USD is more volatile than the EUR/USD pair. Major pairs such as EUR/USD, GBP/USD, USD/JPY, USD/CHF, etc. are more liquid than Minor pairs such as EUR/AUD, GBP/CAD, GBP/JPY, etc. The least liquid assets in the FX market are exotic pairs. Learning how liquid your trading instruments are, what influences their value, when they are the most active during the day and what the volatility is like are critical for profitable trading. Good liquidity brings tight spreads and more trading opportunities for traders. When it comes to stock trading, the most liquid markets are NASDAQ and New York exchanges, which attract traders and investors from all over the world.
Trading without understanding risk management
Failure to manage their risks is the number one reason why most beginner traders fail. For most, risk management seems easy, never risk more than you can afford to lose, however, it’s a bit more complex than that. Let’s discuss each aspect of proper risk management. Other than technical risks, there are geopolitical and global risks that humans face collectively.
Leverage and trade size
Leverage is a double-edged sword. It helps traders to increase their purchasing power. Brokers offer various leverage ratios. In most tightly regulated areas, available leverage is limited to 30:1 and 50:1. Some brokers offer up to 200:1, 500:1 or even 1000:1 leverage. Keep in mind that by choosing high leverage, you’ll be able to double your money fast on the markets, but also, lose everything fast as well. Such an approach is gambling, and you should treat trading as business and not as gambling.
Most professional traders avoid risking more than 1 or 5 percent of their trading balance per trade. The more frequently they trade, the less they risk per trade.
Risk to reward ratio
Most traders decide 1:1 risk to reward ratios when it comes to trading FX pairs or better. In stock trading, reward ratios are even higher. How can you decide what ratio is suitable for your style? Well, the answer is simple, the one that produces the desired outcome, is the best. There are two ways two make money in the market when it comes to risk to reward ratio. The probability of success can be 50%, but the ratio needs to be 1 risk, higher than 1 reward. Usually, rewards are 2 or 3 or higher when traders use 50% success rate strategies. And the second way to make money is having a 1:1 risk to reward ratio but a higher success rate.
What makes decision-making difficult is the fact that some traders are not giving clues about risk to reward ratios. For instance, let’s say your trading strategies are aimed at joining trends and riding them. While generally, such strategies can be very beneficial, there’s usually no clear Take Profit targets prior to joining the trade. Typically, trend trading takes profit orders based on how markets behave. If a trend is strong, it’s best to stay and ride it for maximum results.
Over Reliance on economic indicators
Technical indicators are highly useful, but one should not use them blindly. Every indicator shows something, they make reading the markets easier. Keep in mind that if a trend trading indicator tells you to buy and the market is in range, you will most likely get stopped out. Every indicator should be used based on market conditions and context.
Indicators can be used in conjunction with other indicators or trading strategies. The more tools you use to give you trading signals, the more precise your trades will be. However, using too much can decrease the quality of your trading. Digesting too much information at once often causes analysis paralysis and instead of acting, traders let great opportunities waste.
Moreover, technical indicators are purely technical. They do not include fundamental data such as interest rates, trade balance, political events, inflation, central bank policies, etc. It’s always best to keep an eye on economic and political news when trading. It’s worth mentioning that traders that find it difficult to follow economic news, and prefer pure technical trading, avoid placing orders during or prior to economic news announcements. To be successful, you need to find your trading style. There’s a million ways to make money in the markets.
Failure to manage emotions
Human emotions are dangerous in trading. Profitable and consistent trading is based on cold calculations, probabilities and logic. We all have our emotions, but as a trader you need to learn to make sure, your emotions do not dictate your decisions.
When it comes to trading, the most dangerous emotions include:
- Fear and Greed
- Hope
- Revenge trading
- Boredom and laziness
Greed leads to overtrading and placing oversized orders, and fear leads to not taking great trading opportunities, both of which are very dangerous for traders.
Traders are hoping that their orders will be profitable when they are unprepared and do not trust their own trading system. It’s critical to test and backtest your strategies before going live.
Revenge trading occurs after a series of losing trades. Losing traders cut their winning trades short and let losing one’s run and deplete their balance. Successful traders do the opposite.
Boredom and laziness can also be very negative in trading. It’s easy to feel bored when you are a swing or position trader and the opportunity doesn’t present itself for weeks. Boredom leads to opening orders that are not worth the risk. It’s critical to understand these challenges and work on your strategies to eliminate them.
Trading without a plan
Trading without a solid plan is a terrible idea. Every trader needs a set of rules that will help them to make the decision-making process easier. A well put together trading plan should include:
- Which instruments should a trader use
- How should the market conditions be determined and analysed
- Life and work balance. How much time will be for trading, analysing and how much will be for family and friends.
- Emergency situations. It’s critical to have an emergency plan in case you are in a trade and lose an internet connection or there are power outages. Typically, a mobile trading app is a great emergency tool for such events.
- How will a trader develop his or her results? It’s essential to constantly work on upgrading and creating new strategies as market conditions often change. Moreover, it’s critical to learn from your own mistakes. Usually, a trading journal is a great way to achieve this goal.
Trading without a journal
As already mentioned, trading journals help traders learn from their own mistakes. Most professional traders use them because they are really helpful in developing traders and their strategies. A well put-together trading plan should include:
- Reasons for entering a trade
- Reasons for exiting
- Stop Loss and Take Profit orders
- A screenshot or a sketch of a trade
- Technical details such as market conditions (Trending/ranging), Open price, closing price, profit or loss.
- Emotional and physical state of the trader before and after the trade.
Going through the records can reveal patterns that increase the probability of losing or making money. For instance, a trader might notice that feeling tired before a trading session leads to poor results, etc. Trading journals have many other benefits too. Trading journal improves accountability. When a trader knows that his trades will be saved at the end of the day, he is more likely to be selective and more careful.
Trading without short, medium and long term goals
Having short, medium and long term goals are a must for success in any field. Trading is no different. Every trader’s goals can be different based on their level of development. Professional traders aim to have consistency in their trading, as consistency attracts investors. In addition, when a trader is consistently profitable, compounding becomes possible.
Beginner traders, short to medium goals, are not losing trading accounts while developing working trading strategies. At the same time, novice traders are focused on developing themselves. Beginners goals are learning how to trade. While professionals are trying to learn how to be more disciplined.
Not preparing enough technically and financially
As already mentioned, trading is not a job that will give you a steady pay cheque at the end of every month. Trading is like a business, and traders should be ready for drawdown periods. Ideally, the trader should have put aside enough funds to live without withdrawing money from the account.
In addition to creating an emergency fund, traders need to get ready technically. A good quality internet connection is a must. Moreover, you don’t need a 6 screen PC, but 1 good-sized computer monitor can make your life way easier.
Traders require an office space, where they can analyse and trade in a calm and professional environment. It’s also recommended that you use an office chair, or a gaming chair can also work.
Simming it all up
To sum everything up, trading might seem easy from the start, but it takes a lot of work and preparation. Trading profitably and consistently requires avoiding various pitfalls:
- Having wrong expectations
- Trading without a deep understanding of the markets you are trading
- Trading without understanding risk management
- Overreliance on economic indicators
- Failure to manage emotions
- Trading without a plan
- Trading without a journal
- Trading without short, medium and long term goals
- Not preparing enough technically and financially
