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In this section, I discuss some of the most common mistakes made by both novice and seasoned traders. I also provide solutions on how to fix these errors.
The key is to first identify mistakes through self-awareness and focus on the process, and then fix them one by one. If you try to solve all the problems at once, you will get overwhelmed and will eventually prove detrimental to your development. Slow down to reach the speed you want to be faster.
While not at the top of the list below, risk management is an area that needs to be addressed immediately, whether this is your first or 1001st day as a trader.
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MISTAKE #1 – NO TRADING PLAN
Few traders have a real game plan, they are literally flying blind. Your trading plan doesn’t need to be very detailed, just a few pages. But the more detailed the better. Your plan should include risk management parameters, an overview of the decision-making process, preferred trade settings (including some reference examples), and how to handle drawdowns and winning periods.
MISTAKE #2 – POOR RISK MANAGEMENT
One of the biggest mistakes traders make is poor risk management. Taking too much risk per trade is a trap that traders must avoid. You must act within your comfort zone or your decision-making process will be severely hindered. Fear and anxiety will almost certainly cause you to make mistakes, leading to depression and more mistakes. Inconsistency in position size is another major issue that can lead to inconsistent results. You should keep your risk margin per trade relatively narrow. For example, if you risk 0.5% on one trade and then 3% on another, it will be difficult to be consistent.
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Another problem is poor risk metrics. Traders often face risk-reward ratios of 1:1 or worse. This forces you to do more right than wrong. A 50% win rate is reasonable depending on your trading style, but at 1:1 you can only break even (regardless of transaction costs). You want to put the risk/reward in your favor and make sure you get paid for the risk you take. A risk-reward ratio of 1:2 provides the desired asymmetry in your risk profile.
Make sure you always use your stops and most importantly stick to them. Not using stops is a dangerous play, and moving them is essentially the same as not using them.
Understand the overall risk of all the positions you hold simultaneously. You can hold three positions with normal risk per position, but due to the high correlation between trades, you are actually holding one large position. For example, if you are long three pairs of Japanese yen, you should treat the three separate positions as one larger position and spread the risk over the three positions.
MISTAKE #3 – UNDERCAPITALIZED
You must understand your personal financial situation and only risk what you can afford to lose. Knowing the downside is not only about prudent money management, it also reduces the stress of risk and uncertainty that you cannot afford. Trading is hard enough without adding extra stress and complexity.
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MISTAKE #4 – OVER-TRADING
Traders have been victims of this situation. Too many mediocre deals mixed with high-quality deals will equate to sub-par performance. There is often a negative correlation between activity level (number of trades) and profitability. High number of trades = low profitability, while low number of trades = high profitability. When traders are more selective in choosing their options (meaning sticking to a solid trading plan), they are generally more efficient.
How can we become more efficient? Use the checklist to help you stay on track. The checklist should reflect your trading plan. Physical checklists are recommended for new traders, but as you become more experienced you will be able to go through the process in your head. A list of reasons for entering trades and risk parameters will help you avoid trades you should not be involved in.
MISTAKE #5 – OVERCOMPLICATE
Remember this acronym – K.I.S.S. just stay stupid. More is not necessarily better, more is often just more. The confluence of two or more factors can give a reasonable approach, but make sure that the factors are not highly correlated. For example, you don’t need three different ways to define a trend or an overbought/sold condition.
For technical traders, a good combination could be – a factor used to identify trends, support/resistance, overbought/sell and the quality of price action. This combination will result in a comprehensive approach that relies on independent factors to judge whether to trade.
MISTAKE #6 – FOCUSED ON RESULTS NOT THE PROCESS
Traders are often understandably confused about trading results. But like any performance-based activity, this will prove to be very detrimental in the long run because you ignore the process you need to follow in order to see positive results. The trade is to know where you are at all times and to correct your course if you find yourself lost.
Here are some ideas to help you focus on the process: review your trading plan regularly, keep a journal, regularly review your trading activity, and take regular breaks from the market to reflect. All of these are effective in keeping you connected to what you’re doing and helping you stay steady.
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