Traders generally buy and sell more frequently and hold positions for much shorter periods than investors. Such frequent trading and shorter holding periods can result in mistakes that can wipe out a new trader's investing capital quickly. Here are some common mistakes you want to avoid, as these are the main reasons many new traders fail.
TRADING WITH A POOR WIN-RATE AND/OR REWARD/RISK RATIO
There are two trading statistics that you want to keep an especially close eye on. Your win-rate and risk/reward ratio.
Your win-rate is how many trades you win, expressed as a percentage. For example, if you win 60 trades out of 100, your win-rate is 60%. As a day trader, you will typically want to keep your win rate above 50%.
Your reward/risk ratio is how much you win relative to how much you lose on an average trade. If your average losing trades are $50 and your winning trades are $75, your reward/risk ratio is $75/$50=1.5. As a day trader you want to keep your reward/risk above 1, and ideally above 1.25.
If you keep your win-rate above 50% and your reward/risk above 1.25, you are a profitable trader. You can still be profitable if your win-rate is a bit lower and your reward/risk is a bit higher, or vice versa. Try to keep it simple though and utilize strategies that win more than 50% of the time and offer a better than 1.25 reward/risk ratio.
NOT TRADING WITH A STOP LOSS
Have a stop loss order for every single trade you make. A stop-loss is an order that gets you out of a trade if the price moves against you by a specific amount. Having a stop loss assures that you get out of a losing trade. The price didn't move how you expected, so there is no reason to stay in the losing trade. Take the loss and move on to the next trade.
A stop-loss is placed at a location that shouldn't be touched if you are right about the direction the price will move in the short-term. A stop-loss order should be placed at the same time a trade is opened, not after. You want that stop loss to be active as soon as you enter a trade. If you haven't placed a stop loss, it can't control your risk.
- Tips: Learn how to use NAGA Protector.
Placing a stop loss on each trade helps control risk and also helps to avoid a common problem called "averaging down." Averaging down is when you make additional trades, adding to your position, as the price moves against you. Adding to a losing trade is a dangerous practice since the price can move against you for much longer than you expect.You are not only exiting a trade that is losing you money, but you are also making that position larger, which means the loss gets exponentially bigger the more the price moves against you and the more you add to the position.
Take a trade with the proper position size and set a stop loss on the trade. If the price hits the stop loss the trade will be closed at a loss. There is no reason to risk more than that on a trade that is not doing what you expect. Small losses are much easier to recover from than large losses.
LACK OF RISK MANAGEMENT FOR EACH TRADER AND EACH DAY
Position size was mentioned above. Proper position sizing is part of the risk management strategy that all traders should have.
The first part of your risk management strategy is to establish how much of your capital you are willing to risk on each trade. Day traders should ideally risk 1% or less of their capital on any single trade. That means that a stop loss order closes out a trade if it results in no more than a 1% loss of trading capital.
Only risking 1% per trade is ideal because even if you lose multiple trades in a row only a small amount of capital will be lost. At the same time, if you make 2% or 3% per winning trade (discussed in the risk/reward section above), losses are easily recoverable and it’s possible to make great day trading returns even though the risk is kept relatively low.Another part of risk management is controlling daily losses. Even with risking only 1% per trade, if you take a lot of losing trades in a day you could lose a substantial amount of your capital. For that reason, have a daily stop loss. For example, you may choose to have a daily stop loss of 3%. If you lose 3% of your capital in one day, you stop day trading for the day.
GOING “ALL IN” OR ALMOST ALL IN ON A TRADE
Risk management was just discussed, but it's important to bring up "going all in". Even if you have a risk management strategy in place, there will be times you are tempted to ignore your risk management rules and take a much larger trade than you normally do. Reasons for this may include:
- You have had several losing trades in a row, and you want to make back all the losses (and maybe some profit as well) all on one trade.
- You are trading very well lately, and feel you can't lose, so taking a larger position than usual isn't that bad.
- You feel very confident that you can't lose on this particular trade, so you are willing to risk almost everything on it.
Stick to your 1% risk rule per trade, and your 3% risk rule per day (or whatever small percentages you personally decide to risk). These figures do not change based on your emotions or how you feel about a trade.
Never risk more than a couple per cent on a single trade, because if you start risking 5%, 10% or more of your account, you can start losing substantial sums of money very quickly.
If you risk too much you are already making a trading mistake, and mistakes tend to compound. If this big losing trade starts moving against you, you may feel regret which can lead to removing your stop loss order in the hopes the price will turn around and you can avoid the loss.
Worse yet, you may add to the position, hoping that if it turns around you can make an even larger profit. Avoid such situations in the first place. Stick to your risk management strategy, and avoid going "all in," no matter what the reason.
ANTICIPATING HOW NEWS WILL AFFECT THE PRICE
High impact scheduled economic news releases cause assets affected by the news to rise or fall sharply. Anticipating the direction the price will move, and taking a position before the news comes out seems like an easy way to make a windfall profit, but It isn't.
Often the price will move in both directions, sharply and quickly, before picking a more sustained direction. That means you will likely be in a big losing trade within seconds of the news release.
Now you may be thinking "Great, with all that volatility the price is likely to swing back in my favour and I can take a profit!" Maybe it will, maybe it won't. But there is another problem. In those initial moments, the spread between the bid and ask price is usually much bigger than usual, which means you may not even be able to find liquidity to get out of your position at the price you want.
Instead of anticipating the direction news will take the market, have a strategy that gets you into a trade after the news. This approach still allows you to profit from the volatility, but without all the unknown risks.
OPEN MULTIPLE TRADES THAT ARE CORRELATED
You may have heard that diversification is good. Well, even that is arguable, (Warren Buffett said that "Diversification is protection against ignorance. It makes little sense if you know what you are doing.") but assuming you believe it you may be inclined to take multiple trades at the same time instead of just one, thinking you are spreading out your risk. Chances are you are actually increasing your risk.
If you see a similar trade setup in multiple symbols, there is a good chance those are correlated...that is why you are seeing the same or similar chart patterns in each one. When pairs are correlated, they move together, which means you will probably win or lose on all those trades. If you risk 1% on each, and take five trades, if you lose on one you will probably lose on all 5, resulting in a 5% loss...not 1%! By taking correlated trades, you have inadvertently increased your risk.
If you take multiple trades at the same time, make sure they move independently of each other.
DAY TRADING OFF FUNDAMENTAL OR ECONOMIC DATA
It is easy to get caught up in the news of the day, on an article or video you saw that says economic conditions are good/bad for a country/currency/share etc.
The long-term fundamental outlook doesn't matter when you are day trading. Your only goal is to implement your strategy, no matter which direction it tells you to trade. "Bad" investments can go up temporarily, and good investments can go down in the short-term.
Fundamentals have absolutely nothing to do with short-term price movements...so don't even bother looking at fundamental analysis while day trading. It will not serve you well.
TRADE WITHOUT A PLAN
Everything discussed so far should be included in a trading plan. A trading plan is a written document that outlines exactly how what and when you will trade, the trading plan, and the strategies it contains, give you an edge in the market and prevent you from “gambling”.
- Your goal is to follow your trading plan precisely. Your trading plan should also be precise, so it is easy to follow.
- Your plan should include what markets you will trade, at what time and what time frame(s) you will use for analyzing and making trades.
- Your plan should outline your risk management rules, as discussed above.
- Your plan should also outline exactly how you will enter and exit trades, for both winners and losers.
If you don't have a trading plan, you are gambling. Create a trading plan and test it for profitability in a demo account before utilizing it with real money.
AVOID THESE COMMON TRADING MISTAKES
If you make these trading mistakes, it is quite likely you will fail in your journey to becoming a successful trader.
Trading isn't easy; it takes work and commitment to the personality traits that allow you to avoid these mistakes. In summary, monitor your win-rate and reward/risk ratios; failing to do so means you may be using a strategy that has no chance of producing a profit.
Always use a stop loss and don't add to losing trades.
Set a risk cap for each trade and for each day, and never go "all in" (or almost all in) on a single trade.
Trade news volatility only after the news is released, and don't place trades before the news.
Avoid taking multiple correlated day trades, as it increases your risk.
Trade with a plan and save yourself time by not considering fundamental analysis while day trading, traders should still pay attention and take care of the positions due to high impact events in the economic calendar such as an ECB, FED meeting or when the Non-farm payrolls are reported etc.
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