10 Common mistakes to avoid in stock trading
10 Common mistakes to avoid in stock trading
Written by the Millennial Trader
Learning to invest and trade stocks is a constant battle of trial and error. The most successful traders are not born overnight; they are the ones who choose to learn from their mistakes and failures until they know what mistakes to avoid. Today, knowing which mistakes to avoid is easier than ever because we have the power of the internet where old traders are teaching newbies by example. Free advice is at our fingertips, but it’s hard to sift through and filter to find the best advice. The following lists the ten most common mistakes stock traders tend to make.
- Expecting too much too soon
One trait of a successful stock trader is patience. Stock traders must be willing to trust their research to learn when to hold off and lower expectations. If one gets into the stock trading profession expecting immediate gratification with every trade, one should adjust expectations accordingly. When we compare our positions or timeline to that of another trader, we are only harming our expectations in the long run. Instead, we must learn to focus our efforts and belief in the trades we are making because there is no guarantee of results when it comes to trades. “Expecting a portfolio to do something other than what it is designed to do is a recipe for disaster” (Artzberger, 2022).
- Letting emotions rule
One of the worst things a trader can do is let emotion start to rule their trades. Humans are emotional beings, but we can retrain our minds and bodies to fight these instinctive emotional urges and follow reason in its place. Although regulating emotions is not easy, breaking free from these emotional chains is possible. Fear, envy, greed, and regret most commonly arise in a stock trader’s life. These emotions are powerful because we trust them blindly, even though they are unreliable reflections of reality. For instance, when traders experience fear of missing out on trends, we buy; when we feel paranoia when others begin to sell, we sell. Additionally, when we feel the greed that arises when we physically are unable to sell, infinitely waiting for the price to rise higher, all of which cause us to make drastic decisions not rooted in logic or reason.
- Waiting to break even
Greed is a complex emotion to shake because it is rooted in a mindset of need and fear (of poverty). Waiting to break even is a trait often seen in gambling addicts, who keep investing more of their money to ‘break even’. Stock traders are no different. Learning to accept losses just as we accept wins is an integral part of being a trader. If we waited until we broke even on every unfavorable trade or investment, we would go into a lifetime’s worth of debt. Behavioral finance calls this a “cognitive error.” By failing to realize a loss, investors are losing in two ways. First, they avoid selling a loser, which may continue to slide until it is worthless. Second, there is the opportunity cost of the better use of those investment dollars (Artzberger, 2022).
However, if we accept the loss and choose to turn it into a learning experience, we will get much further and become better investors because of it. Emotions also lead us to attach to specific stocks; once we become attached to a stock emotionally, devoting more money and focus to it than others, we are putting ourselves at risk. Detaching from our emotions is the only way we can start to make logical trades and consistently perform better as the market changes because we can handle the ebbs and flows better.
- Attempting to time the market
The idea that we can time the market is naive thinking and leads to many missed opportunities. Because the market cannot be easily tamed or manipulated, successfully timing the market is nearly impossible. Additionally, timing the market has never proved a contributing factor to portfolio success. Instead, we should focus on our decisions, the amount we invest, and how consistently we trade while continuing to build a diversified portfolio.
- Failing to diversify
Adequate diversification is the only way to create a portfolio with the potential to survive the surprises market changes bring. Finding the balance in diversification is key to ensuring we are more widespread but still in control of all our investments. One of the standard rules traders should follow: avoid allocating more than 5 to 10% to any single investment (Artzberger, 2022).
- Ignoring longer time frames
More extended time frames are underestimated in the trading world because we want the immediate gratification that shorter time frames can provide. However, this short-term mindset trains us to get sucked into only utilizing 1-minute or 5-minute time frames, not taking advantage of the hourly, daily, and weekly frames. The longer the trend, the more durable it will be, allowing longer time frames to exert much greater control while most short terms fail. Even experienced day traders get blinded by short time frames and ignore the long term. And yet they could perform better if they broadened their perspective just into hourly frames.
- Following trends/relying on others
When we learn from our research and not trends or other opinions, we are free to reap possible rewards from pulling away from the herd, but also learn from our mistakes and use them for the future. Furthermore, when we make a trade on our own, there is no one else to blame, which forces us to take responsibility, reflect, and grow.
- Not practicing in a simulator.
Just as an athlete must practice before playing in a game, a stock trader must practice trading first in a simulator, also called “paper trading.” Thus practice allows them to get comfortable, gain confidence, and perform best, like any athlete perfecting their skill. For those who have never used a simulator before, Trade Ideas offers a state-of-the-art, real-time AI simulator. We use simulators to gain confidence, trade, and learn while never having to spend a dime.
- Not using a stop loss.
A stop loss is an order placed to buy or sell a stock once it reaches a selected price. Stop losses are an underrated and often overlooked tool for stock traders; some people need help understanding their necessity but placing a stop loss at the right price makes all the difference. If we have a stop loss, we can emotionally detach and allow it to save us from a potential career-ending loss.
- Poor risk-to-reward ratio
Risk management is imperative to finding success as a trader and will change over time, but this ratio should remain consistent in trades once finding a strategy that works best. Traders have to walk a fine line between taking too much or too little of a risk or taking the wrong risk entirely; finding the balance is key to becoming a more consistently profitable trader. If we risk too much, it can lead to significant variations, while taking too little results in lower returns, leaving us unable to meet our financial goals.
A significant reason most traders need help finding the right balance and keep repeating this mistake is FOMO or fear of missing out. FOMO encourages traders to blindly follow the herd/trends to the extreme to avoid missing out on potential opportunities, usually resulting in excessive risk-taking. A good rule of thumb for those who struggle with risk management is to “only trade what you can afford to lose (no more than 2% of capital on a single position” (Farley, 2022).
Farley, A. (2022, April 20). Seven common trading mistakes. Yahoo! Finance. Retrieved December 7, 2022, from https://finance.yahoo.com/news/seven-common-trading-mistakes-074838195.html
Artzberger, W. (2022, July 8). Avoid these 8 common investing mistakes. Investopedia. Retrieved December 7, 2022, from https://www.investopedia.com/articles/stocks/07/beat_the_mistakes.asp