Four Mistakes Rookie Equity Traders Make
Brad Barber & Terrence Odean of Berkeley published an interesting study in 2000. Titled "Trading is hazardous to your wealth: The common stock investment performance of individual investors", the study concluded, besides other things, that the average individual investor under performs a market index by 1.5% per year, while active traders underperform by 6.5% annually. Talk about working doubly hard for nothing at all!
Anecdotal evidence would confirm that most traders who venture into the perilous world of flipping stocks and derivatives with the intent of reaping a profit, end up burning their fingers - if not immediately, then eventually.
If, against all odds, you plan to be a trader of anything stock market-related, here are three mistakes you need to avoid at all costs.
Not having - or sticking to - a trading plan
Not having a robust, well-defined trading plan in place is a sure shot way to set yourself up for trading failure. Your plan should ideally include specific rules for entering a trade, the universe of securities to trade, and exit rules. Most traders enter and exit securities based on whims and tips - in the end, that amounts to blind speculation. Successful traders "plan their trades and trade their plans"
Not sticking to stop-losses
The famed loss-aversion bias makes it extremely difficult for most traders to humbly exit trades when their defined stop losses are triggered. Somewhere deep down, hope of a recovery continues to float. Perhaps, in the past, there have been instances when you stuck to your stop loss doggedly, only to see the position recover after you exited. This exacerbates the aversion to sticking to stop-losses. The best approach would be to define the stop loss at the time of entering the trade, rather than executing the trade manually when the stop-loss level is hit.
Not having a concrete profit-taking strategy
In their 2009 study titled "Fight or flight? Portfolio rebalancing by individual investors", Calvet, Campbell, & Sodini observed, unsurprisingly, that investors tend to sell winners quickly, while holding on to losing trades longer! The reason behind this is the fact that many traders have stop-loss rules in place, but very few have profit-taking rules in place. Resultantly, they often end up booking profits too soon or too late. A profit taking strategy can be defined in percentage terms, or in terms of technical (chart) indicators.
Trading excessively
Another bias, the "Action Bias", prompts many traders to trade excessively; especially when markets are rife with hype, and the noise can be heard from a mile away. It's worth knowing that most of the world's top traders who have been profiled actually stay away from the noise, preferring to isolate themselves and trading with quiet and controlled discipline instead.
Trading to Recoup
Winning Traders know that the odds will never be 100 per cent stacked in their favour - in fact, most are happy to get half their trades right, with stop losses ensuring that the losses borne do not outweigh the profits booked. Rookie traders, on the other hand, tend to get unsettled by losses. Resultantly, they jump into the market as if with a vengeance, with the intent of 'taking back what is lost'. These emotion-fuelled 'recoup' trades are very likely to end badly.
