Common Trading Pitfalls and Mistakes

This article is an abstract of the book:
The Complete Guide to Daytrading

Compared to daytraders, position traders usually have much more time to make a decision and to enter or exit a trade. Their decisions are made using general price targets. They do research on the stock, read the news and earning reports and then make decisions with a long-term target in mind. They ride the plays where the stops are wide.

You can't daytrade that way because you will lose all your money. But many daytraders are also position traders or former position traders, so it's important to know the difference between the two. This chapter is perhaps the most important in this book because it will give you an idea of the reasons why so many traders fail as daytraders.

In our opinion, position trading corresponds more closely to human nature than daytrading. Position trading forgives mistakes more generously, it gives traders more time to make decisions and it's simpler - but not easier - to do. It is much more in accordance with the human character. For example: in daytrading you must buy at the bottom without seeing any "confirmation" whereas it is much easier to buy something that is already moving up because it confirms your own decisions. Also, position traders don't need to sell immediately if the price drops below the entry point. They give the stock more time to develop. Position trading is hard work and needs a great deal of experience, but it is much more in tune with human nature than daytrading and so it is easier for most people.

Short-term daytrading, however, doesn't forgive even the smallest mistake. There is almost no space for mistakes in daytrading. You also have very little time to make decisions, and if you make the wrong decision you have to cut your losses and exit the trade immediately, without hesitation. You can't afford to ride a trade down. Many daytraders have gone broke by doing this.

Daytraders need to make most of their money within seconds or, at most, a few minutes. The reward is they get paid immediately if they are right. The bad news is that they must also pay immediately for their mistakes.

At the end of a day, a short-term daytrader knows exactly how much money he has made or lost. He liquidates all his positions and ends the day in cash. Each single trade gives a report and some feedback about its success. If you make mistakes, you will have to pay for them instantly. If you do it right you get paid instantly in turn. This continuous and instant reaction to what you are doing may sometimes cause serious emotional problems. It's hard to keep your emotions under control, especially if you are doing very well or very badly. To succeed in daytrading, however, you must make decisions that are absolutely correct within a very small time frame and this means you can't afford to let your emotions mar your judgment.

Daytraders need to stick strictly to the rules, otherwise they fail. It's that simple. But this goes against basic human nature and so many daytraders fail because they can't handle the emotions, the stress, and having to stick to some very strict rules. The difficulty is to maintain this, not only for a few trades - everybody can pull himself together for a limited period of time; if you want to do daytrading for living, you must be able keep control of yourself each minute of every single trading day. That's the real challenge. It will take some time before you have learned all the rules, but it will take much longer before you can make a living by sticking to them. And you can't stick to rules if you can't keep your emotions under control.

Remember:
You don't have to trade all the time.
You don't have to make a large number of trades.
You don't have to use big share sizes.
You are NOT under pressure.

Our chat room will give you an environment in which you can focus on your trading. The room is strictly regulated to avoid any disturbances. In it you will only find traders who have the same aim as you, trading the same patterns as you. They are all trying to learn daytrading together. Any hype is prohibited and will lead to an immediate ban from the room.

The most important thing traders need is the ability to focus on the really important things without being distracted. Alert-Trading provides that kind of environment for you. We assume that our traders want to make money and want to learn daytrading to make a living. They can't do that if there are too many distractions.

There is no way to make big money other than to work hard for it, although we must say, when you consider the amount of work you have to do daytrading and the money you pull out it if you succeed, daytrading is clearly overpaid. Once you have learned the right way to do it, you will make more money than you have ever dreamed of.

The most common and most serious mistakes:
Not keeping the stop loss
Chasing
Trading fast stocks
Trading low percentages
Not being self-disciplined and not sticking to the rules
Not having a plan and a clear set of rules
Taking profits too early
Not taking a profit when you need to
Holding overnight
Averaging down
Making it back
Overtrading - doing too many trades
Not picking the appropriate route for execution
Not having the right broker
Not having reliable technical equipment

Stop Losses
Never ever hold a stock that is hitting your stop loss price. Always exit without hesitation when the target is hit. Don't think, just do it. Remember, traders go broke because they don't stop their losses. Act like a robot, just hit the button. If you have learned the patterns well you'll know when to stop. When you don't know when to stop, don't trade. You must know the exit price before you enter the trade. You must know where you will exit when things go wrong and where you will take the profit when things go well.

Chasing
Chasing is one of the biggest mistakes you can make, and one of the hardest to prevent. Traders like to see some confirmation before they go long (or short). They see a stock selling and they know there is a good opportunity coming up to go long. They see the stock making a bottom and instead of buying, they wait for some confirmation. The stock bounces and they enter their order too late. Unfortunately that's the worst time to enter a trade long for three reasons:

1. You will find it hard to get a fill because everybody is buying and nobody is willing to sell a stock that is bouncing.

2. You pay a high price for your confirmation. It's our experience that chasing can cost � to � point extra per trade. That has an enormous impact on your performance because it reduces your profit dramatically. Since you are a daytrader, the average profit for a trade usually is in the range of � to 1 point. You make your living by pocketing smaller profits several times a day. You can't afford to leave money on the table because of chasing. The chaser enters the trade when other traders are already contemplating exiting it.

3. If you are wrong, then your loss or stop is greater because you have paid a higher price for the stock than traders who bought at the bottom and didn't chase. Let's assume a stock plunges to 30 x 30 1/8 and stops selling there. Trader A buys the stock, gets a fill at 301/16. He joined the Bid when some folk were still trying to sell the stock. Sometimes he even gets a fill below 30 because other traders panic and sell below the Bid. Trader B hesitates, looking for confirmation. He knows it would be a good idea to go long but he isn't sure. The stock starts moving up, within a few seconds the quote is 30 1/4 x 30 3/8. Buyers are lining up now at the Bid. They see the stock bouncing. They try to get a fill but it's difficult. The sellers are backing away because they see the stock bouncing. They are waiting until they get a higher price. For a buyer, there are not many shares left because now more of them are fighting to get in.

Trader B recognizes this and knows he has to pay the Ask price to get the trade. With some luck he might get the stock at 30 3/8. If he is even luckier, he might get a complete fill and not just a partial, because he certainly won't be the only one trying to get in at the Ask price. Trader A is in at 30 1/16 and has a nice (paper) profit already, while the buying is just getting started. He knows that he is in a strong position to get an easy fill at the Ask. Buyers will be pleased take his shares and pay the spread for him. He decides to enter a limit sell order at 30 15/16 and waits until somebody takes him out. He knows that most traders will sell at round numbers, so he doesn't sell at 31 but 31 15/16 to be one step ahead of all the other sellers. He is right. Buying was good and he got the fill. He has made a profit of 7/8 of a point.

Trader B exits at the same price with a profit of 9/16. Trader A made 5/16 more than trader B. Plus:

*Trader B could easily have missed the trade. He was lucky to get a fill.
* Trader B was lucky to get all the shares he wanted. He could easily have got a partial fill only.
* Trader B made a good profit because the bounce was very good.

But what happens if the bounce is not so good? What if the stock bounced only a little bit? The stock would pull back to 30 and selling wouldn't stop. Trader A and B would exit the trade at 30. Trader A would be out flat or with a small loss, B would make a 3/8 loss. If this sort of thing happens several times a day, each trading day, it could make a big difference to each trader's long term profits.

It really isn't easy to buy when there is still no sign of major buying interest. You need experience to do that. You need a great deal of self-confidence to know when you are right. It will be some time before you have sufficient experience to be completely self-confident. Nobody can trade without having some losses from time to time; losses, after all, are part of our every day lives. But you can learn to identify high probability trades, and being able to recognize high percentage trades makes it much easier to buy at the bottom and to overcome fear.

Wait for the right trade
Don't force trades. Wait for the high percentage plays to come to you. Everything else may lead to losses. Many traders make good money and lose it all later with low percentage plays, just because they couldn't wait.

Stick to the rules
Act like a robot. Don't think, just act. If a high percentage opportunity comes along, take it, because you will have learned to recognize one when you see it. Stop out if it goes lower. Don't hesitate, just do it. Exit if the target is hit and take the profit. Once again, don't think. Do it. It's wrong to change the rules or think about them during trading hours. Either you trade or you think about your rules. You don't have enough time to do both. Remember, you must remain totally objective and in control at all times.

It's a good company
People often blow their stops or just buy and hold (buy and hope) because they say to themselves: "It must go up, it's a good company, the fundamentals are great, earnings are better than ever ." But we ask: Who cares? If markets sell down, your stock will go down, too. No one asks how good the earnings have been, they just sell the stock because it's going down. You must decide whether you are a position trader or a daytrader. For a daytrader, information like P/E, earnings, and so on is worthless. You are in the trade for a few minutes, a few hours at the most. How much can the earnings or P/E ratio have changed in those few minutes? No one cares. The current momentum of the stock and the market direction is much more important. Think about what's important now, and what may effect your trade now. Check for breaking news, watch the NASDAQ and S&P; 500 futures, check the pace of the stock, the spread, the current supply and demand with Level II, and the Tick indicator for NYSE and NASDAQ.

Averaging Down
You buy a stock, it goes down. You buy more, it goes lower. You buy more, etc. That's averaging down. A fatal mistake. You say to yourself: "If the stock was interesting at a higher price, it's even more interesting now at a lower price. This sounds logical and may even be true, but it breaks another rule that has a much higher priority: Stop out of a losing trade.

There is no doubt which is better out of averaging down or stopping out and re-entering the trade. Stopping out and re-entering is a much better proposition, for several reasons:

1. If you are out of the trade, you can watch the sell off objectively and make an intelligent decision. Do you really want to re-enter? Is the trade still interesting or did you make a mistake and the whole trade hasn't been good anyway?
2. In most cases stopping out costs much less than averaging down.
3. If you are in a situation where you are thinking about averaging down, you are already admitting that you have made a mistake: you entered the trade too early. What makes you so sure that entering the stock again isn't another mistake? What if you are wrong again?
4. The stock may never come back to your entry point.
5. Staying in ties up too much money.
6. The stock may make several new lows, taking your average entry point higher and higher. Every time you average down, you invest more money in a sucker play, and that can end in disaster.

There are situations where you can't stop out very easily because the stock plunges like a rock. If we are stuck in a blown stop it's very difficult to make an objective decision, even for an experienced trader. We all hope that a blown stop will come back to us, nobody wants to sell at a low point then watch the stock bounce back to the entry price. However, you must be very aware that your emotions can easily cloud your judgement in a situation like this. If you are not 100% sure of what you should do, stop out before the situation gets out of control.

Taking profit
Taking profits can be a mistake, especially if you take them too early or, for that matter, don't take them at all. Many traders have this problem because they fear that they might lose their profit if they hold it too long or they might miss an incredibly good profit if they exit too soon. That's true, of course. If you hold too long you can easily lose your profit. If you don't hold long enough, you can miss a good run. The key question is: What is too long?

If your fear gets the better of you, you will sell before a target is hit and you will be out too early, making a loss: you will have lost the difference between what you did earn and what you could have earned. You must have a target price at which you will sell the stock and you must stick to it. Other traders have a problem with taking the profit. They always believe that the stock will go up much higher. If you have no fear of losing your profit, maybe you are greedy. Maybe you are waiting for a greater profit but the target has already been hit. We all want more profit, but you must be realistic about it. Again, set a reasonable target price and exit there. Don't think, just press the button.

We should set our target prices before we enter the trade, just the same as we do with our stop loss prices. We should do this for a very good reason: to set your stop and profit targets, you have to think clearly about the trade and judge the risk and the potential before you enter it. This clears your mind and prepares you properly for the trade. Once you are in the trade, your emotions may influence your judgment much more than you would like. Many other details may influence you as well. Once you are under pressure you can't make proper decisions, so it's much better if you have made them before you enter the trade. Don't tell us you don't know how much the stock will go up. You must know. If you don't know, you shouldn't be entering the trade, because otherwise you are merely gambling. The patterns tell us what is possible and what is not. If you don't know the target prices of the trade then you are not ready to trade the stock.

Failing to exit the trade
If there is anything you don't understand, exit the trade immediately because you have just lost control over it. You can't just hope that it will go in your favor. You need to have control over yourself to control the trade, so it's better to exit immediately and to think about it objectively from a safe distance.

Making it back
If we lose money, we become frustrated and want to get it back with the very next trade. This is a dangerous attitude and can lead to serious losses because you aren't objective anymore. The traders' most powerful weapons are patience, discipline and objectivity. There is no way other than waiting for the perfect trade to come to you. You can't force trades. You can't decide: "This is it. I'll trade now and make some money. " You can only take what the markets give you.

A loss makes us impatient. We want to make it up as soon as possible to compensate for feeling stupid because we made a mistake. However, we must wait for the right chance, otherwise we risk losing even more.

Think professionally. Turn losses and bad trades into opportunities to learn. Try to shut out all emotions. Pay up and learn your lessons, or you'll find yourself paying the price for making the same mistakes over and over again. It's that simple.

Impatience
Impatience is one of the daytrader's greatest enemies. A daytrader spends most of his time waiting for the perfect trade to appear. Some days are extremely busy, but others are slow, and sometimes we simply can't find a good trade. It is therefore very important not to make the mistake of trading just because you are bored or impatient. That's low percentage trading, and low percentages equal losses. There is a right time for everything, so stick to it. You can only make money if the markets are ready to give it.

Arrogance
Many successful traders say that their biggest losses occurred right after they had made a big profit. By accident? No. The markets are merciless. The more successful you are, the more careful you have to be because you are trading with a bigger share size. An error with a large share size can lead to fatal losses. Also when we make money, we feel good, we loosen up a little and we get careless. At a certain point we even believe we can't lose. Each new trade is a new chance to make money, or to lose it. Stocks don't care how you feel. If you get careless, you will have to pay for it.

Holding overnight
Overnight positions are very risky. Read more about this in the chapter entitled: "Opening prices, gaps, overnight risks."

Trading fast stocks
Many new traders make the fatal mistake of trading the hot stocks. These promise fast and fat profits, but all they usually earn you is a fatal loss. We see this happening every day and we wonder why traders keep doing it. For example: IPOs usually move very fast. The pace is extremely high and quotes are often delayed because of the large amount of action, but greed is more powerful than reason and the traders jump in regardless. Fast moving stocks are for very experienced traders only.

You don't need fast stocks to make good money. They don't usually have good risk-reward ratios, so if you are not experienced in trading them, you'd be gambling with your money if you touch them.

We sometimes watch other chat rooms and we always see the same thing. Headtraders are calling the fast stocks because they want to provide some action for the room members. It's a nice show. The lucky winners are posting their trades, but you don't usually hear from the losers. The headtraders are yelling: "Winner Alert! Winner Alert!" The headtraders are the stars because they have provided their members with a multiple point profit. That looks good on the homepage as well. There you can read +1,000% performance for the year, +30% today, etc. That's entertainment. In any game show there's a winner for the day and nobody cares what happens after that. Nobody complains that the spread was 1 point, the quotes were delayed, the risk was incredibly high and getting a fill had more to do with luck than good management. Those seem to be unimportant details.

Overtrading
Overtrading is when you do too many trades. Don't trade because you are bored or you like the action. Trade only when the odds are in your favor.

Wrong order routing
You should pick the proper way to execute your order every time you do a transaction. Many traders are not flexible enough. They always use the same route to get a fill. Some try it with SOES, some with ARCA, others with Island, all the time. They don't switch to a different route when it's necessary to do so. Learn to work with all of your order execution functions. Learn everything there is to know about the different ECNs and how to trade with market makers. You can find all the information you need about these in this book.

The wrong broker
Using the wrong broker is one of the biggest mistakes a trader can make. The wrong broker can cost you thousands of dollars each month when your orders are executed too slowly, when you don't get price improvement, when you can't join the Bid or Ask, when you can't cancel quickly enough, when you have to pay for partial fills, and so on. Read the chapter: "Picking the right broker."

Wrong technical equipment
Don't cut back on the equipment costs. You will be depending on your system so it has to be totally reliable. Read about a proper system setup in the chapter: "Technical Equipment."