How to Avoid the Most Common Day Trading Mistakes - dummies

How to Avoid the Most Common Day Trading Mistakes

By Michael Griffis, Lita Epstein

If the risks and costs don’t scare you away from day trading, you need to become familiar with some common mistakes that lead to failure for many day traders. Here are some of the more serious mistakes new day traders make:

  • Breaking stop-loss rules: When a stock starts dropping, newer, not-yet-disciplined traders tend to panic as their picks begin losing money, so they decide to hold the stock rather than exit when their initial stop-loss is reached. However, traders go broke using that strategy. Follow those rules mechanically when the target price is hit, and don’t let your emotions get in the way.

  • Chasing trends: New traders often wait to see confirmation that they’re right before they enter a position. That hesitation causes them to miss planned entry points and, if they’re right, can end up forcing them into buying at a stock price that’s higher than they intended when an upward trend is expected or selling at a lower price than they intended when a downward trend is expected.

    By missing intended entry prices, traders end up chasing the trends and finding that their original entry and exit points no longer are valid.

  • Not waiting for the right trade: A new day trader must exhibit the patience required in waiting for the right trade to match what the technical analysis indicates. Experienced traders know to wait for the right timing instead of forcing a trade, entering at the wrong price, and overtrading their account.

  • Not establishing set rules before the trading day begins: To avoid getting caught up in the emotions of a big win or loss, you need to decide your entry and exit points before the trading day begins and never deviate from them after the day begins.

    Experienced day traders know that you either focus on your trades or think about your rules. Don’t do both. Staying objective and following your rules is crucial to maintaining the control a day trader needs.

  • Forgetting that fundamentals don’t matter: New day traders get caught up in the idea that the company whose stock they’ve purchased is a good company and that when its stock loses ground, it’s therefore bound to head back up.

    Experienced traders know that how good the fundamentals look doesn’t matter and that when the market is selling down, even the price of a good stock goes down. Day traders must follow market signs and not worry about how good or bad the fundamentals of the company they’re trading may appear.

  • Averaging down: Although investors may average down, meaning they buy a stock and if the price goes down they buy more shares believing that it will recover, this technique doesn’t work at all for day traders, and most experienced traders will tell you that using it is a fatal mistake. Day traders instead believe that you need to set a stop price and get out of a losing stock.

    Doing so gives you time to look objectively at what is happening with the stock and determine whether getting back in is worthwhile. Stopping out also is likely to cost you less than averaging down, and you won’t risk getting caught with a margin problem. Averaging down can tie up too much money that otherwise can be used for a more profitable trade with a different stock.

    The worst feeling, even for an experienced trader, occurs when a stock plunges far below the stop position because deciding whether to take the large loss is difficult. In most cases, if you’re uncertain of your next move, experienced traders recommend that you get out of the position before the situation grows worse or out of control.

  • Not knowing when to take profits: New traders sometimes make the mistake of either taking profits too early or not taking profits at all. Most of the time, indecision strikes when traders are afraid they’ll lose a profit if they hold it too long or miss a profit if they exit too soon. Exit points need to be determined before entering a position, and rules need to be followed.

    Remember that as a day trader you must focus either on your trade or on your rules. Day traders who move into and out of positions within seconds or minutes don’t have time to do both.

  • Walking away from the computer with open positions: Experienced day traders never walk away from their computers when they still have an open position. Because experienced day traders respond to price changes that occur in mere seconds or minutes, they definitely don’t want to be away from the screen while a position is still open.

Day trading is a high-risk career choice that you should consider only after doing a considerable amount of initial research, hunting down good resources for educating yourself about the risks and rewards, and finding all the techniques you need to use to day trade successfully.

Even before you get started, be sure to check out the firms you’re planning to use as resources by calling up their disciplinary records and complaint histories through the SEC or state regulators. You’re putting a good deal of money at risk, so take the time to find out all you can before spending even that first dime.

You also may want to consider taking your Series 7 exam, the exam all stockbrokers are required to pass. Although you must be sponsored to take the exam, many training centers near your home or online can help you find a sponsoring broker.

Even though you may never want to work as a broker, the information you’re required to know for the exam gives you a much stronger awareness of the securities markets and the laws by which they’re governed. Studying for the test, you’ll also discover more about the various investment products on the market and the risks you take when buying and selling each type.