Common Trading Mistakes and How to Avoid Them

No trader is perfect, but you don’t have to repeat some of the most common mistakes. Knowing what to avoid can help you develop good trading habits and potentially increase your returns. Rather than learning these mistakes by enduring big losses, you can review this compiled list of common trading mistakes instead of burning through cash.

1. No Defined Trading Plan

Successful traders don’t make decisions on a whim. They construct trading plans and know which indicators to monitor before putting any of their capital into an asset. Many traders set limits on how much they are willing to lose in a single trade. It’s also common to see traders exit after a position nets a sufficient profit, usually defined as a percentage.

Traders establish these rules in advance so they don’t panic and succumb to emotions when the market becomes volatile. They are also less susceptible to getting distracted by shiny objects if they have clear trading goals and parameters.

2. Lack of Market Research

If you don’t study financial markets, technicals and fundamentals, you will be guessing with every trade. People who guess with trades are more susceptible to following the crowd. These traders may hold their assets for too long or bail based on emotions rather than a defined strategy.

The best traders also stay on top of the broader market. That includes geopolitical and economic factors that can influence asset prices. 

3. Overdependence on Automation

Robo-advisors and other algorithmic tools can assist with trading, but you should never rely on them. It’s important to establish your parameters and do research without relying on artificial intelligence. Traders must understand how automation fits into their trading strategy and what the software is doing. 

You have to regularly monitor any automations in your trading strategy and assess if you have to make any adjustments to the plan. Robots and software can help you make more trades, but they can’t do the thinking for you.

4. Overleveraging a Single Position

You never want to be married to a single position. Putting all of your money into one asset increases your exposure and risk. If that one trade performs poorly, it can wipe out all of the gains from various successful trades. 

Instead of overleveraging into a single position, most traders put their capital into multiple positions. That way, if one position doesn’t perform well, other positions can prop up the portfolio. Experienced traders know how to size their positions based on their risk tolerance and objectives.

5. Holding Onto Losing Trades

You won’t win every trade. Even the most experienced traders still endure losses and have to cut ties with bad positions. However, the losses from a bad trade can compound if you hold on to it for too long. 

The sunk cost fallacy may cause less experienced traders to hold a losing position for longer than necessary. Even if you invested a lot of time and effort into the position, it’s important to know when to walk away. Freeing capital from a losing trade gives you more resources for your next big trade.

6. Overdiversification

Although there’s a benefit to diversifying your portfolio, traders should also avoid overdiversifying. You don’t have to open dozens of positions each day or tap into assets that you don’t know much about. 

Too many positions can lead to overwhelm and make your strategy extremely complex. This setup can result in more losses as you try to juggle data points and trends for numerous assets.

7. Misusing Leverage

Leverage allows traders to enter more positions than their cash would allow. For instance, if you have $10,000, you can use leverage to have $20,000 in purchasing power. While leverage can amplify your gains, it can also accelerate your losses if your trades move against you.

It’s important to understand how to manage margin to avoid triggering margin calls. Furthermore, you should only trade as much as you can afford to lose. Some people keep margin positions for too long and end up having to sell assets at unfavorable levels.

8. Ignoring Risk/Reward Ratios

Traders should look for assets with favorable risk/reward ratios instead of ignoring this key detail. For instance, an asset that has soared in recent weeks may not present a favorable risk/reward ratio. However, a stock that’s down on strong earnings may present a better risk/reward after the market’s reaction.

Contrarian investors often find favorable risk/reward setups. They aren’t afraid to zig when others zag. 

9. Letting Success Cloud Judgment

Success can be more dangerous than failure. Some traders feel like they are invincible after placing a few good trades. This type of hubris can lead to a trader’s downfall, as they feel more comfortable making risky investments. They may stop considering the downside because they have a big winning streak. A single bad trade can wipe out winning trades if you let recent successes cloud your judgment.

10. Emotional Trading

The best traders use data and logic to make their decisions. They enter and exit positions methodically instead of succumbing to their emotions. Fear, greed and frustrations are three of the strongest emotions that you will have to overcome. 

Don’t feel bad about trades that go poorly, nor feel inclined to revenge trade your way in the pursuit of regaining what you lost. Each trader must build emotional discipline and follow their strategy. You can make adjustments to your strategy, but you should have time to think over any adjustments instead of making impulsive changes. 

Becoming A More Successful Trader

Avoiding the common trading mistakes can help you become a more successful trader. Knowing the common pitfalls can help you develop trading habits and strategies that keep you away from blunders.

You still won’t win every trade, but you can increase your probability of success by learning more about markets and trading every day. You won’t become the best trader within a few months, but you might end up with sizable returns if you continue to trade for several years.