Here is a video link to an interview that I did at the World Resource Investment Conference last week, click here to watch on YouTube.
Trading is simple, but not easy. Despite its simplicity, most people who try to trade have a hard time finding consistent profitability. Trading well is as much about doing certain things right as it is about avoiding the common mistakes. Here is a list of the common causes of trader failure.
1. Lack of Knowledge
Trading does not have to be complex or involve a sophisticated understanding of capital markets. In one day, I can teach a person the skills that I use as a trader. However, like riding a bicycle, being good at applying those skills takes practice and usually involves some painful mistakes through the learning process. You probably were pretty wobbly the first time you pedaled a bicycle but, with time, you found your balance and got good at it. Trading is no different.
However, unlike riding a bike, there are thousands of ways to trade. You have a choice in what you trade, the hold period for your trades and the strategies you apply.
There are many options for people looking to learn trading. You can take classes, study online, read books or try to figure it out on your own. Each approach to learning has a cost; don't underestimate the price for how you intend to learn.
With so many approaches to acquiring the knowledge you need to trade, there is not necessarily just right and wrong ways to learn. It becomes a question of what is right for you, what best fits your learning style. What is most important is that you get educated before you risk a penny of your money in the market. Most people can't beat the market because they don't know what they are doing. Don't let a lack of knowledge ensure your failure.
2. Poor Risk Management
The focuses for most aspiring traders are the decisions to enter and exit the trade. They spend a lot of time trying to find the right stock to buy and then try to make a good decision on when to enter. They miss out on the most important component of the trading process.
Risk management is that often forgotten piece of the trading puzzle. Without capital to trade with, you have nothing to do. Protect your capital first and never try to get rich overnight. Some might get lucky in the short term but those who fail to manage risk over the longer term will go broke. That is guaranteed.
For every trade, you need to know your downside. Being wrong is part of trading so you must have a plan for what to do when you are wrong.
3. Insufficient Capital
Since being wrong is part of a profitable trading strategy, you need to allow for drawdowns of your capital base. There will be times when market conditions will not be great for the strategies you are applying.
When planning your trading business, you must allow for this potential deterioration of capital. You may make five steps backward before you start to go forward, make sure you have the capital to ride out these losing periods.
4. Trading Without Proven Strategies
I have seen a lot of people trade without a strategy that they have tested. They think that they can beat the market by doing things that make sense. This is often the biggest problem with people who are successful in other areas of life.
It is a bad idea to think that you can beat the market by being smart. The markets rarely do what makes sense, at least in the context of the information that we have. This is because the market often moves on information that most of us just don't have.
For that reason, it is smart to have a set of trading rules that you first test exhaustively before you trade. Your testing must determine whether the rules yield a positive expected value. Over a large number of trades, your rules should make a profit. What happens on any individual trade really does not matter.
5. Failure to Follow Rules
The rules you define and test are only effective if you follow them. While this is easy for all of us to understand, it is a very hard thing to actually do. We break rules because we are afraid of losing money. Emotion is a hard thing to overcome.
To minimize the impact of emotion requires a comfort with the risk you are taking. Most traders find that paper trading, simulated trading without using real money, is not too hard. It is only when they have their capital at risk that they start to make mistakes.
The solution to this problem is to not take more risk than you are comfortable with. The best traders are those who don't care about the money. The more you can do to take out emotion, the better your chances will be to follow the trading rules.
6. Lack of Determination
Doing anything well requires the determination to learn and gain expertise. This is very much the case for trading because it is such an emotional pursuit. There will be times when the novice trader will feel overwhelmed with emotion and ready to give up.
I don't think trading is something that can be done well by someone who does not like it. Having a passion for trading is what will get you through the hard times and ensure that you stick with it when your heart may tell you otherwise.
7. Poor Focus
The shorter the time frame you trade, the more focused you need to be. Position trading (hold period measured in weeks or months) is not that demanding mentally because you have a lot of time to make your trading decisions. Swing trading (hold period measured in days) requires you make quicker decisions but is not as demanding as day trading. The day trader (hold periods measured in hours or minutes) has to make decisions in only seconds and work hard to not miss out on good trading opportunities.
It is hard to trade if you have a lot of distractions while you are trading. You have to do what is necessary to avoid letting outside factors have an effect on your trading decisions.
8. Inability to Adapt
The market is constantly changing and you need to be able to adapt with it. That means applying trading strategies that are appropriate for the present conditions; you may not want to apply a buying strategy in a market with strong downward momentum.
Avoiding chasing the market with your rules is a challenge that many traders have trouble with. You should have a set of trading principles that do not change over time, these based on source of opportunity that you are pursuing. Do not constantly change the rules of your tested and proven strategies.
However, how and when you apply your strategies will change as the market evolves. I keep a stable of trading strategies that I apply as conditions warrant.
Markets took a step in the right direction this week with the bounce back that I was expecting. The indexes have not overcome the pessimism yet but could do so soon, watch for a break of the downward trend line on the major stock market indexes. In the mean time, there are a few stocks able to do well despite the market weakness. This week, I ran the Stockscores Simple strategy Market Scan and found a few stocks with decent charts. Here they are with my comments:
DRAD made an abnormal up break with abnormal volume on Friday, taking it through resistance from a rising bottom. Good potential provided it does not pull back to close below support at $2.16.
A good ascending triangle break on UNIS Friday with abnormal volume supporting the break. The reward for risk will improve with a pull back. The stock is breaking its long term downward trend, a good sign for a turnaround. Support at $3.95.
A nice weekly chart breakout from a cup and handle pattern on TCAP as the stock moves to five year highs after sitting under $20 resistance for over a year. Support at $19.75.
- Get the Stockscore on any of over 20,000 North American stocks.
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This is not an investment advisory, and should not be used to make investment decisions. Information in Stockscores Perspectives is often opinionated and should be considered for information purposes only. No stock exchange anywhere has approved or disapproved of the information contained herein. There is no express or implied solicitation to buy or sell securities. The writers and editors of Perspectives may have positions in the stocks discussed above and may trade in the stocks mentioned. Don't consider buying or selling any stock without conducting your own due diligence.