Over the years I have seen some repeated mistakes new traders make, and most are relatively easy to avoid if you are disciplined. Before I get into my list of the top five trading mistakes, I’ll mention one more that applies to trading as we move closer to the 4th of July holiday and the summer doldrums. In holiday markets, volume tends to be quiet at times, and that means markets can whipsaw, especially overnight. One large order can move a market significantly. We often see a lot of “noise” going on as we head into a holiday that might not be a true reflection of market fundamentals. It’s a time that’s harder to trade, and might not be the best time to initiate new positions if you aren’t an experienced trader. But if you do want to trade, avoiding the pitfalls is even more important.
1. Trying to Pick Market Tops and Bottoms
This is a very common mistake with rookie traders or investors. People think they can perfectly time the market. Ask yourself: can the market go any higher or lower? Of course it can. Crude oil is a perfect example. Last year the price of crude oil rose to above $147 a barrel, then in just six months, fell to under $35. People were trying to pinpoint the top from about $90, and many got run over. Trying to pick tops and bottoms in any market is a losing cause; the odds are against you. There are only two points on a chart that have an absolute top and bottom. There is more profit potential in the meat in between the trend, once you identify it.
To identify a trend, I look at chart patterns. The entry and exit are the harder parts to identify. I use moving averages, MACD, and the Relative Strength Index to help me determine whether a market is overbought or oversold. Study different technical indicators. Find ones that you are comfortable with and that work for you.
If a market is trending, I’d want to buy on pullbacks. Watch for profit-taking in the markets within the trend, and see if your indicators show it might be a good time to get in. If I see a big economic report coming up, I might avoid that trade until the dust settles. Then I’ll look at specific support points on my charts to help me determine exit points.
2. Overtrading
You don’t want to let your emotions dictate your trade. That’s part of the reason people overtrade. People tend to over-react to market movements, and it affects their psyche. Trading futures is a very mental game. You need to keep your emotions in check. Trade based on what you know, and what you see. Overtrading tends to be mainly a problem for day traders.
To avoid overtrading, have a plan and stick to it. Trade the chart, not the money. You don’t want to become overconfident. Once you get overconfident, you start trading more, and it’s not the right way to approach the markets. On the flip side, many traders who are on a losing streak try to make the money back and overtrade, adding to their position. They are not trading with the right mindset and a small loss becomes a big one.
If you see yourself doing these things, step away from the screen, take some time off and reassess. The trades will come. Be patient. If the setup is not there, there is no reason to trade. Get out of losing trades before they become big problems; don’t try to dollar-cost average when trading futures.
3. Over-Leverage
The basic definition of leverage is the use of various instruments to increase one’s rate of return. In futures, that means you can put up a small amount of capital to control a much larger contract value. In regards to business, leverage refers to using heavy financing for various activities. While leverage is an appealing characteristic of futures markets, leverage is a double-edged sword in futures trading. It can be great, because you are using a small amount of money to control a large investment, but on the flip side, you can lose a whole lot more too.
Being able to define and control your leverage is key to longevity as a trader. If you have a small account, you need to know what markets are reasonable for you to trade. Know your risk tolerance, and know your limits.
4. Improper Money Management
Sound money management can be the difference between success or failure, even if not all your trades are winners. Make sure your account size fits the particular markets you want to trade. You have to be able to assess your risk tolerance. Always have an exit strategy on every trade before you get into the trade. Use protective stop orders, which can take some of the emotion out of trading. It’s not how you get into the market, it’s how you get out that can make the difference in your success. Even the best traders aren’t always right. A professional trader knows when to get out of a losing trade quickly and lets the winners ride.
Be able to take losses. You aren’t always going to be right on every trade. That’s just reality. The reason you want to cut your losses early is that a few big winning trades can offset many losers, but one really bad trade can wipe you out completely. It’s not fun to get stopped out of a trade, but you’ll be glad you got out when the market keeps moving against you. You’ll be able to trade the next opportunity when it comes along. Live to fight another day.
5. No Trading Plan
Many people have a “get-rich quick” mentality when it comes to futures trading. That’s the absolute worst mentality to have. You need a plan. If you don’t have a trading plan, you are going into a gunfight with a blindfold on. If you have a trading plan, you will have a strategy for entering and exiting positions, and you’ll know your risk tolerance on each trade. I also recommend keeping a trading journal. You can’t improve as a trader unless you know what didn’t work in the past. You can look back and determine what you should correct going forward.
These are just a few of my thoughts on trading. Feel free to contact me with any questions that you have about the markets.
Ben Kim is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at 800-355-5757 or via email at bkim@lind-waldock.com. You can follow Ben on Twitter at http://.twitter.com/LWBKim.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
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