In this article, IG Group runs through the five biggest mistakes they see traders make: from letting profits run to following the herd.
Every trader makes mistakes. But what separates the experts from the rookies is their ability to learn from them.
That doesn't just mean learning from your own missteps, either. Researching the mistakes made by the thousands of traders that have gone before you is a great way of getting a head start as you navigate the markets.
Here are five common mistakes to avoid as you trade.
What are the top mistakes traders make?
1. Letting losses run
One of the biggest mistakes made by traders of all experience levels is to let losing positions run for longer than they should. It’s a natural reaction to a trade that’s in the red – hoping that your loss will be reversed instead of facing up to the regret that comes with accepting a poorly chosen position.
Research by CFD trading provider IG Group found that clients make more successful trades than unsuccessful ones, but that the losses from failed trades often outweigh the profits made on winning ones. This bears out earlier research by Odean, which examined 10,000 traders from 1987-1993 and found that they held on to losing trades for far longer than winning ones.
2. Taking profit too soon
But traders don’t just let losses run – they also take profit from successful trades too soon. Both of these mistakes come from the same source, referred to as loss aversion bias.
Just as individuals are reluctant to realise a loss, they are too quick to embrace the positive sentiment that arises when realising a profit. When combined, these mistakes can lead to traders making a net loss even when they are picking the right opportunities.
One way of negating the effect of loss aversion bias is to use stops and limits. By deciding when you’re going to cut loss or take profit ahead of time, you can prevent emotion from clouding your judgement.
3. Failing to plan
A trading plan is the single best method of avoiding all the mistakes we mention here – and many more.
Every trading plan is unique. Forex trading, for example, requires a different approach to long-term investing. But by setting out what, how and when you’re going to trade ahead of time, your individual plan helps remove emotion from your trading and gives you guidance to follow when the pressure is on.
One aspect of mastering the markets is to learn when to stick with your plan rigidly, and when to adapt it to new market conditions. You can’t adapt what you don’t have, though, so make sure you have a comprehensive plan before you open your first position.
Confidence is a requirement for trading. You’ve got to have the belief that you can earn a profit, or you’ll never get started.
But overconfidence can lead to poor decision-making. This is borne out by a study from Dorn and Huberman, who surveyed over 1000 German investors and found that those who considered themselves more knowledgeable than others were prone to excessive buying and selling.
No matter where you are on your trading journey, keep confidence in check and stay realistic about your experiences. Top traders like Martin Schwartz have often said that they’ve made their biggest losses while basking in the afterglow of a major win.
5. Falling prey to the herd
Herding refers to the pressure traders feel to jump on the bandwagon when there’s a significant market trend, even when there’s no real reason to open a position. Herding can exacerbate moves, inflating the prices of assets because investors haven’t done their research properly.
The dotcom bubble is a classic example of herding. Thousands of traders piled on tech stocks out of fear of missing out on the next big thing – but when the bubble burst, those who had held back were better off.
Find out more about the psychology of trading: including how emotions and biases can affect your profits.