12 Huge Trading Mistakes to Avoid - dummies

12 Huge Trading Mistakes to Avoid

By Michael Griffis, Lita Epstein

Here are twelve huge trading mistakes that befall experienced and novice traders. Take a look at the suggestions for helping you recognize the mistakes and for avoiding and even correcting them.

Don’t go bottom fishing

Bottom fishing — trying to catch a stock as it bottoms out — is a great way to get soaked and lose a bucketful of money. In a bear market, stocks get much cheaper than most of traders expect or want.

As long as traders remain interested in a stock, many are the moments when it seems like the stock may recover. Only after the momentum crowd loses interest does the stock’s downward price slide end. When value investors begin nibbling, the stock begins to stabilize; however, it also may spend a very long time in a trading range.

Your best opportunity for profit occurs when the stock breaks out of its trading range.

Avoid timing the top

Tops and bottoms share something in common. They rarely arrive when they’re supposed to. When traders and investors are exuberant, they keep buying even after doing so no longer makes fundamental sense. That’s why shorting a stock that’s trending higher makes no sense, even if its price is far beyond reasonable. Don’t guess. Wait for reliable trading signals.

Don’t trade against the dominant trend

Trading against the dominant trend in the market leads to costly mistakes. Unfortunately, misidentifying the trend by focusing on the chart in front of you is an easy thing to do. You may see a promising uptrend occur with a pullback on the intraday charts. On the daily chart, the trend you saw on the intraday chart actually turns out to be a consolidation rally during a strong downtrend.

The promising pullback actually is the beginning of the next leg down on the daily chart. If you buy long in a situation like this one, hoping to capture the next leg up, your position will be swamped by the flood of sell orders coming from traders who recognize the implications of the longer-term stronger trend.

Don’t wing it

Traders get into big trouble when they wing it. Maybe you heard the guy on business TV say the stock was hot and heading higher. Although that may sound like great information, it’s not a reason to buy today.

Devise a strategy. Plan your trades and execute your plan. Wait patiently for your signals to trigger your trades and don’t second guess yourself.

Trading isn’t personal

A losing trade is bad for your trading account, but you can’t let it get to you. A bad trade may reduce your net worth, but it shouldn’t damage your self-esteem. Entering a losing trade certainly doesn’t mean that you’re a nincompoop — any more than closing a winning trade signals your brilliance.

Don’t fall in love

Trading is a business. Your stocks are your inventory. Smart business owners don’t fall in love with their inventory. It’s there to sell, at a profit if possible, at a loss if necessary. And smart businesspeople don’t fall in love with their business models.

After-hours market orders are a bad idea

When the market opens, the market order that you placed last night before going to bed is going to be swept up in a wave of frantic trading. Bad fills are sure to be the result. Never place a market order when entering trades after the market is closed. Instead, define your limits by using a stop order, a limit order, or a stop-limit order.

Avoid runaway trends

If you miss the breakout entry point for a stock that you want, waiting is better than entering a position as a trend accelerates. Often, stocks will pull back and test the breakout point. Wait for that point, or wait for the stock to take a short breather after its first leg up. If you’re still interested, that’s a better entry point.

On the other hand, if you already have a position in a runaway stock, try planning your exit so you leave a little money on the table. Capturing every last nickel of the trend is almost impossible. Instead, consider trimming your position as the stock reaches for the stratosphere. If you’re using margin, consider taking some profit off the table and reducing your leverage a bit.

Don’t average down

You sometimes hear advisors suggesting it as a way of reducing your cost basis, but it’s merely a technique to throw good money after bad.

However, averaging up makes some sense. Traders call it pyramiding. The idea is to add to your winning positions when your trading system triggers new trading signals in the direction of the trend.

Ignoring your stops is a bad idea

Talking yourself out of honoring your stops is an easy thing to do. You’ll be tempted when a trade goes against you. When you start thinking you want to give a position a little room to work its way out of losing territory, you’re on your way toward a trading debacle. Unless you’re omniscient, close the position when the price hits your stop.

Avoid diversifying badly

You can monitor only so many positions and do it well. You need only so many positions to diversify your risk. And although you can have too few or too many stocks in your trading portfolio, no perfect number exists. That said, you nevertheless have to figure out what the right number is for you.

Don’t endure large losses

Your success as a trader depends on how you handle losing trades. If you dispose of the losers quickly, you can become a very successful trader. But if you hold on to those losing positions, you can lose so much money that it may knock you right out of the trading business.

Using margin exacerbates the problem of losing trades. Margin is a wonderful thing, because with careful application it can magnify your profits. But on the flip side, with indiscriminate use it can also magnify your losses.