The main difference between stock trading and investing is the quantity of trades and the length of time that securities are held. Traders typically buy and sell stocks and other securities on a more frequent basis and hold onto their purchases for a shorter period of time. The reason for this is that traders want to capitalize on market volatility in order to maximize profits.
Stock trading can be very lucrative when done right. The ability to buy a stock at a relatively low price and then sell that stock at a higher price a short time later has the potential to produce sizeable gains. However, frequent buying and selling increases the risk of making mistakes which can quickly wipe out all or a significant portion of a beginner’s trading capital.
Here are five of the most common mistakes made by traders.
1. Not Having a Trading Plan
Traders often become impulsive and make irrational decisions in the absence of a sound trading plan. How do you know when to buy and sell if you have no plan? What profit margin are you looking for? How much of a loss are you willing to sustain? It will be extremely difficult to create a repeatable process that produces consistent results without a good trading plan.
On the other hand, establishing a solid trading plan will allow you to set clear objectives in regard to how much of a gain you need on your trades and when you need to make the trade. You can establish annual, monthly, weekly, and even daily profit goals. This gives insight into when to sell because you will sell when you have met your target. Additionally, you will limit your losses by exiting a wrong-way trade when you hit your predetermined loss limit.
2. Investing with Your Emotions and Not Logic
Investing with your emotions usually leads to losses. Your emotions may tell you the best time to invest is when the stock market is doing well and everyone else seems to be making a ton of money. However, the market may be in a bubble at that point and ready to topple. On the other hand, you may close out a position too early because you are afraid you will lose your profit. Your emotions also may lead you to make investments that are not in line with your long-term goals or your short-term tolerance for risk.
Obviously, it would be better if you could make your decisions based on logic rather than letting your emotions control your investing. That way, you can ride through situations that otherwise might cause panic. In order to do that, you must adhere to the guidelines you previously established and wait for a particular signal that tells you when to buy or sell. Learn to view your trading as a business that you manage in accordance with previously established rules and procedures.
3. Not Trading with a Stop Loss
Losses are an inevitable part of trading. You should not be trading if you cannot tolerate losses. However, you do not want your losses to accumulate to the point that your trading becomes unprofitable. You can limit the amount of money you lose on any one trade by using a protective stop that will automatically initiate a trade when your losses equal or exceed a predetermined amount.
There are two basic types of stop-loss orders: market and limit. Some brokerage firms may simply refer to them as stop orders and stop-limit orders. Stop orders buy or sell a security at the market value when the stop value has been hit. Stop-limit orders also buy or sell a security when the stop value has been hit but only if a predetermined limit price can be realized. The main difference between these two is that stop orders will always be exercised when the stop value has been hit, but stop-limit loss orders may not, making them riskier.
4. Not Using Probability
In order to be profitable, you need to know what the probability is that your trade will be successful. There are several tools available to help you make that determination. One of these would be to use fundamental analysis. On an individual stock level, this requires looking into a company’s financial health, such as profit and loss statements, and its year-over-year revenue growth. On a more general basis, determining economic health, such as job growth and the prospects of future inflation, can help you determine the probability of a successful trade.
Another way to determine probability is to use technical analysis. Technical analysis involves the examination of charts and indicators to help estimate the likelihood that a stock or index will move in a specific direction. Charts and graphs can be displayed in a variety of styles and types with different frequencies. Various studies and indicators can be added to or overlaid on the charts, including the following:
- Moving Average
- Relative Strength Index
- Money Flow
- Price Channels
5. Solely Focusing on Your Positions Expiration Graph
Some positions, such as options, have expiration dates. They will expire worthless if held too long. A positions expiration graph will help you determine the point at which you have achieved maximum value of the position being held. You can then evaluate whether it would be better to sell now or hold the position longer in the hope of generating additional profits.
Solely focusing on your positions expiration graph, though, can lead you to overlook other factors that should be taken into account. For instance, what would happen if a news event triggered a sudden spike or dip in the market? Is your position tied to a particular company or industry that will be reporting earnings in the near future? The bottom line here is that your positions expiration graph should be viewed as only one of the tools available for you to use in your trading.