Last Updated on August 20, 2022 by
Steer clear of these common trading pitfalls to maximize your returns while minimizing risks:
1) Trading without a Plan
Trading without a Plan is like driving a car blind. You don’t know where you are at and where you are going.
Without a Plan you will get nowhere fast, especially in the investment world. Take the time to develop your goals and budget, which will help define your required return and risk profile. Stick with your Investment Plan.
2) Setting Unrealistic Expectations
When we set unrealistic expectations on trading returns, we have a tendency to bend the rules when the going gets tough. When we bend the rules, we end up making trading mistakes and increasing our risk. Stop. This will lead to financial loss, and perpetuate a cycle of trying to get “caught up” by again making a risky investment. It’s far better to be balanced in our approach.
3) Cutting Profits Short and Letting Losers Run
Before you make a trade, decide on what you want to get out of it and what you are going to do if the market goes for you or against you.
Sometimes we get scared and drop out too early, missing valuable profits. Other times we get greedy, or don’t want to admit defeat, and let losers run far too long in the hopes that the market will turn.
While it is difficult to accurately predict the market, your losses will be lower if you decide your strategy up front.
4) Impatience, which Leads to Overtrading
Control emotions and remain objective in all circumstances. Don’t get impatient and overtrade in a stock or sector. Make intelligent decisions by sticking with your Plan.
Avoid the Trading Emotional Roller Coaster:
5) Improper Position Sizing
Position sizing refers to the amount of money you invest in a certain security compared to the rest of your portfolio. If the position taken in a particular security or sector is too large, you haven’t diversified your risk. Lower your risk through spreading your positions more evenly.
6) Lack of Diversification
Holding all your eggs in one basket, or even just two or three, increases the risk of loss. Diversification in finance means holding a mixture of investments.
It is believed to lower your overall portfolio risk, you should hold at least ten different types of investments. If you are a small investor, you may consider investing in a mutual fund which already includes multiple investments in its mix.
7) Poor Risk Management
In the investment world, managing risk is critical to your success. You increase your risk when you fail to do your homework. You must not fail to step back, to understand, and to analyze the risks inherent in your investment or your portfolio. Best traders understand their risks and try to mitigate them before losses occur.
8) Timing Tops and Bottoms
It’s impossible to consistently outsmart the market. Therefore, trying to time market tops and bottoms is just plain risky.
Lower your stress and anxiety and increase your long term returns by taking a position in solid performing companies and holding those positions as profits run.
9) Trading against the Trend
In the trading world, there is a very simple strategy called “the trend is your friend”. What this means is you figure out the trend or market direction and “catch the wave.”
For example, find a trend that is moving higher, make the investment, analyze and assess, and try to reverse when the trend ends. Stay away from trading against the trend or trying to outsmart everyone else in the market.
10) Focusing on Being Right
In the trading arena, often we are wrong, but getting too emotionally attached to “being right” all the time will not only limit your trading activity, but it also is a reflection that you are focused on the wrong things.
If, for example, out of 10 trades, let’s say nine went south by not performing as you had hoped, and you have to realize losses by selling early. However, the one that was successful out-performed the nine that went bad. The goal is to make a return and not to get focused on being right all of the time.
In the business world, we often say “I can’t see the forest for the trees.” What this means is that if we are so focused on looking at something in detail and separate from the whole (i.e., a tree, being correct on every trade), you will lose perspective on the total (i.e., the forest, the total profit).
Keep your perspective always and monitor your total profit without getting concerned about every transaction.
Jai Maa!