This is PART 2 of this post – Click HERE for Part 1….
8. Buying stocks in a down trend…
If you throw a ball across the garden you don’t expect it to magically turn around mid air and come back to you. This is called momentum – objects in motion tend to stay in motion. So expecting a falling stock to magically start going up is nuts. A simple rule will keep you out of dramas like Enron and crazy stuff like that: NEVER BUY A STOCK THAT IS BELOW ITS 200 DAY MOVING AVERAGE!
9. Getting hurt by one particular stock…
Many traders have been hurt in the past by one stock or another and list the stock as their biggest mistake. In reality the stock is not the (only) mistake here. The real mistake is having a position in that stock so big that it hurts you financially. This tends to happen when traders are expecting (hoping for) a huge gain.
The challenge is we are typically now as good at predicting windfall gains as we would like to think. The solution is to make positions small no matter how big we hope the windfall will be. Success in trading over the long term is more about not losing too much money rather than making it big on one particular trade.
10. Trading penny stocks (sort of)…
Most traders lose a lot of money trading penny stocks, however there is nothing wrong with penny stocks as a vehicle… we just need to use the vehicle in the right way. The max potential loss on penny stocks is large, and the bid / ask spreads are wide. So to avoid big losses we need to keep trades even smaller than when trading larger stocks and not trade too frequently.
Also, just like regular stocks, trading with a well backtested stock trading system removes the emotion, eliminates gambling and hopeful trading. Most traders would do far better using a trading system than discretionary approaches.
11. Ending up in a large drawdown…
One big challenge we face as traders is the asymmetry of gains and losses. A 10% drawdown requires an 11% gain to recover… a 50% drawdown requires a 100% gain to recover.
This means the bigger the drawdown the lower the chance that we will ever recover. So similar to several other mistakes above, the solution is to risk less on each trade. Almost every Trader that I coach comes to me risking too much on each trade because they are trying to make it big quickly. This always leads to large drawdowns and often leads to blow-up.
Manage risk and position size to keep drawdown low and you have a greater chance of winning in the long run.
Trading too much is a huge problem for many traders. The problem is if you are not yet profitable (usually because you are making too many mistakes), overtrading compounds those mistakes more quickly and you lose all your money before you learn the right lessons.
Then even once you are profitable, overtrading causes you to take on too much aggregate risk and so when things go bad you end up losing big. There is no upside here.
I tell my coaching clients: “TRADE LESS TO MAKE MORE”
13. Listening to other people for tips and trade advice…
There are lots of people around willing to throw in their view about which stock is going through the roof and which are dogs that you should dump early. There are also lots of people who think they have some ‘inside knowledge’ or a ‘sure thing’ that you ‘can’t lose’ on. In my experience whenever someone says any of those terms it should be an alarm bell!
In fact, one time I even had a company director tell me something and say the share price was going to skyrocket…now I NEVER take tips so I just smiled and said “That sounds interesting” and watched what happened from the sidelines. The news came out several weeks later and the stock immediately got smashed. You see the problem is just because you know something that is happening doesn’t mean you know how the market is going to react to that information.
I tell my clients this: “Just remember, MOST PEOPLE LOSE MONEY TRADING. That means you shouldn’t listen to the opinion of most people…unless you really want to lose money!”
This also applies to Stocktwits…CNBC…and any other talking head on the TV. I would bet that none of them are consistent stock traders, so none of them deserve your attention. Turn off the TV and follow a stock trading system that you have developed and backtested instead. You will probably make more money with less stress in much less time per day.
14. Holding XYZ stock from $1000 all the way down to $1…
Letting losses grow and grow probably hurts most new traders at some point. I have coached many traders who came to me with portfolios littered with stocks that they should have sold long ago that are still falling.
The flawed belief that “It is not a loss until you sell” is just plain wrong. If you have capital tied up in a stock that is falling then you are incurring a real loss of capital AND you are incurring a huge opportunity cost. Closing trades in falling stocks and redeploying that capital is one of the quickest ways to stop the losses in a portfolio.
Before you enter every trade, you need an exit price – if the stock falls to that level then you get out…no questions asked. This is your initial stop loss. If you implement ANY ONE discipline into your trading it should be having an initial stop loss on every trade!
The trouble is traders facing a loss is kind of like a deer in the headlights on the highway. When you freeze like that you end up getting hit by the truck. Having a stop loss placed in the market ensures that even if you are freaking out at the loss, your broker will still close the position for you. Placing an initial stop loss (provided you leave it alone and don’t cancel or move it to give your trade ‘a little more room’) traps you into success by closing your losing trades.
Use an initial stop loss – it will save your account!
15. Inappropriate allocation of capital…
It is very tempting to allocate capital to trading to just get started, but so many new traders start trading when they have too little money OR when they have high interest debt still hanging over their head. If you have $1000 you are probably going to do much better investing most of that in trading books and learning rather than buying some random stock you hope is going to go up.
Similarly, if you have a credit card debt at 20% interest per year then you should save your butt off and pay off the credit cards BEFORE trying to get rich in the stock market. Earning a certain 20% return by paying off the credit card is way better than an uncertain 20% in the stock market…the first is not taxable because it is reduced after tax expense…the second is taxable because it is additional income.
HOWEVER…I paid off my home mortgage very fast because I was able to make consistent high returns through my stock trading. These returns were much higher (even after tax) than the interest on my mortgage. So where you put your capital depends on how high and how certain the after tax returns are in each of the areas you are comparing.
Finally – if you allocate too much of your net worth to something volatile like stock trading then you will introduce a lot of stress into your life. This is bad because it is hard to make good trading decisions when you are stressed. I pity the trader with his life savings in all in the stock market because they will never sleep very well at night!
16. Selling winning trades too early…
How many times have you been tempted to ‘grab a quick profit’? But did you realize that if you grab a quick profit you will never get a BIG profit? Profits need time to grow and when we snatch a quick profit off the table you are ensuring that you will only get a small profit. Something I tell my trading students is that “The more you try to grab profit with certainty on ONE trade…the more profit across a PORTFOLIO of trades slips through your fingers”.
I believe you can have certain profits or you can have large profits, but you can’t have both. Closing winning trades early is just like letting losing trades go on too long…it erodes your ability to profit at the portfolio level. The problem is that most traders do BOTH – they take early profits on winners and they let their losses grow – THIS IS A PROFIT DISASTER!
Cut your losses and let your profits grow… this is one of the few pieces of trading folklaw that actually works, but why do so few people follow it? Why do so many traders insist on cutting their profits short with profit targets rather than letting them run with trailing stops? It is because they are choosing certainty over profitability. I think that is a poor choice!
17. Thinking “It can’t keep falling”…
Here is the thing – IT CAN KEEP FALLING!
If you ever find yourself thinking that it can’t possibly go any lower…slap yourself! Then remember that you should NEVER hold a stock that is in a long term down trend. You will save yourself a lot of financial pain and stress if you just wait for it to stop falling and then start going up before you buy it.
I am teaching my 7 year old about stock trading and even she can look at a chart and tell you if the long term trend is up or down. I have shown her charts of stocks that some new clients were still holding on to and she says “What are they holding that for? It is going down!”
Just remember that the market can and will go to extremes. You don’t need to pick the bottom to profit, you just need to take a chunk out of the middle of the up trend and you will do very nicely.
18. Putting it all on the line…
NEVER EVER EVER NEVER EVER NEVER EVER put it all on the line in one trade. This is just stupid. No matter how sure you are, there is a chance you could be wrong. If you are wrong you will lost everything and you will be out of the game. One of my favorite sayings is “You have to be IN the game to WIN the game”. If you blow up, you are out and you lose…don’t risk it.