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Humans make mistakes, and it shows that you are trying. Making mistakes is a part of learning and makes you a better trader and an investor. All investing gurus, from Warren Buffett to Peter Lynch, talk about their mistakes and what they learned from them. Now, there are some common mistakes made by beginner traders that you can learn from and avoid. This can save you a great deal of money and give you the financial bandwidth to make new mistakes.
Here are the top five common mistakes made by beginner traders and how to avoid them.
5 Most Common Mistakes Made by Beginner Traders That Can Be Avoided
Trading Without Planning
The first rule of trading is to plan your trade and trade your plan. No trader, beginner or experienced, can time the market. But what they can do is time their exit. When experienced traders trade, they have a well-defined plan. They know their entry and exit points, how much they want to invest, for how long, and what to do if things go south.
This is a crucial point most beginners miss. They just jump into a trade without planning. For instance, some traders short a stock they are long on just because its price is falling. Such instant trades end in losses if you don’t know when to book profit/loss.
Solution: Before jumping into a trade, define your objective, do your research, set an entry price, exit price, and a stop loss. Initiating a trade is the easy part. The difficult part is to stick to your plan. Do not deviate from the plan until there is a material change in factors impacting the stock price. Many beginner traders let greed take over and fail to book profits as per their original plan and land up losing money. When this happens, remember trading is an ongoing process of making small profits and losses.
Compounding Your Losses
One of the most important skills of trading is managing your losses. The stock market can be tempting, and stop-loss is a trigger to that temptation. When you plan your trade, you set a stop loss. One common mistake beginner traders make is compound their losses by buying more stocks at the dip to reduce the average cost of holding. Some even cancel their stop-loss in hopes that the stock price will reverse. Buffett made the same mistake of holding on to a losing stock instead of booking loss at the start. Holding on to a losing stock will not only deplete your capital but also add to the opportunity cost of missing out on a winning trade.
Solution: Do your research and understand why you are trading that stock. And if the reason you were trading for changes, book the loss. You will have more opportunities to make successful trades. The end objective is to limit your losses with stop-loss and overcome that loss in another trade.
Making too many trades in too many things is one of the most common mistakes made by beginner traders. There are many reasons for it. Some traders have beginner’s luck, and they land up making profits in their first few trades. This makes them overconfident, and they land up overtrading. Some rush to trade to recoup the losses from previous trades. Some traders trade in too many markets over FOMO (Fear Of Missing Out). This adrenaline rush to make a trade comes at a price. Every transaction has a cost, tax, and brokerage fees.
Solution: You have to find your equilibrium and work out the math. First, shop around for a broker that suits your trading style and charges a low fee. Then see if the combined risk-reward ratio of all your trades compensates the transaction cost and leaves you with a positive return. And take a break once in a while. You don’t have to trade on every opportunity.
Trying to Get Rich Quickly
The stock market has made some investors rich and many poor. The internet is filled with fake advisors who advertise trade tips to make you a millionaire quickly. Yes, some people have made millions with quick trades, but profits of such trades don’t last long. Maybe your friend made good money from a particular stock, but its good performance could be nearing its end. That is where smart and experienced traders cash out, and those who blindly follow such traders pour their cash in.
Solution: Trading is not about taking high risks but taking calculated risks. Allocate your portfolio to instruments with different risks, with a small portion allocated to high-risk trades. For instance, if you have a portfolio of $10,000, allocate less than 5% towards risky trades, and don’t forget to put a stop loss.
Stopping the Learning Process
The stock market keeps evolving, and new asset classes and trading strategies get introduced. Not all trades work for everyone. Many beginner traders make trades but do not document and analyze them. Another one of the common mistakes made by beginner traders is that they do little to no research. While it is important to know what is driving the stock price, it is also important to understand the trading strategy, especially while trading derivatives.
Solution: As a trader, you need to know your strength and understand what strategy works for you and what doesn’t. You can do this by documenting your trades and analyzing the data. This will help you learn from your mistakes and plan your next trade better. You can also enhance your trading knowledge by reading or listening to learning material, networking with professional traders, and staying updated with the news.
Trading is a long-term journey. Many traders quit early after making unsustainable losses from the above-mentioned mistakes. We hope you avoid the above-mentioned common mistakes made by beginner traders, stay in the game, learn the tricks of the trade and become a serious professional trader!