Are you an investing sinner? The chances are good that if you are a beginning investor, the answer is yes. First, let me define what I mean by beginner. Trading is a profession just like any other, and all professions have a learning period. How long that period is will depend on the individual, and the amount of time they devote to trading each week, but it would not be less than three years.
Now let me enumerate the 7 Deadly Trading Sins:
1. No trading plan
As Yogi Berra said, “If you don’t know where you’re going, you might wind up someplace else.” How will you know if you are achieving your trading objectives if you haven’t defined them? A plan gives discipline to your trading, and stops you acting on impulse. If you can’t find the time to sit down and write your personal trading plan, you shouldn’t be putting your capital at risk.
2. Underfunding
If you are going to make a serious attempt at learning how to make consistent profits from stocks, you need a reasonable starting capital. Opinions vary as to the exact amount, but I would say you need a minimum of US$20,000. If you have less than this amount, you may be forced to risk a larger percentage of your capital on each trade, and three or four losses in a row could deal you a blow from which it is hard to recover. For example, if you lose 50% of your capital you need to make a 100% return to get back to where you started.
3. Overtrading
As a beginning investor you may feel that you have to be in the market all the time, and feel uncomfortable having your trading capital in cash. However, the fact is that this is often the most sensible place to be. Jessie Livermore, the legendary investor from the early 20th century, said, “It never was my thinking that made the big money for me. It always was my sitting.” So remember patience is a trading virtue - if there’s nothing suitable to do, do nothing!
4. Ignoring stops
Whilst researching this article, I went back to my earliest trading journals to see the most frequent mistakes I made. There was one clear ‘loser’ which cropped up again and again, usually accompanied by capitalized exhortations to myself to ‘ STOP DOING THIS’, and that was ignoring stop losses. If you are a beginning investor, I would be surprised if this is not also a frequent sin for you. The reason it’s so difficult to act on the stop, and sell the stock, is that selling crystallizes the loss and proves you ‘wrong’ – you hope that if you hang on a bit longer the stock may recover. If you do this, you are breaking the cardinal rule of trading, to ‘cut your losses and let your profits run.’ When you can take a loss with the same emotion as taking a profit, you can feel you have made great strides in your learning curve as a trader.
5. Emotion-driven trading
To trade well, you need to be able to concentrate and focus. This means that if, for instance, you’re feeling unwell, or have just had a big argument with your partner, it may be a good idea to put trading on hold for the day. It’s commonly acknowledged that stock trading is driven by two dominant emotions, fear and greed, but there are many other undesirable emotions that may come into play. We’ve already discussed boredom, which may cause you to overtrade. Anger after a trade goes against you may cause you to seek revenge. Pride after a series of wins may convince you to risk more than normal. None of these emotions is helpful to your trading. Be like Star Trek’s character Spock – his imperturbable Vulcan attitude will serve you well!
6. Strategy pinball
Are you still searching for the Holy Grail? Beginning investors tend to believe that there is a secret to profitable trading, and if they can just find that secret the money will roll in. So they try System A, until it produces three or four losses in a row, then they switch to System B, until the same thing happens again. It’s rather like switching checkout lanes at the supermarket – whichever one you pick, the other one always seems to perform better! When you find a system that feels right to you, and that you have back-tested through similar market conditions to confirm that it has an edge, don’t be too quick to abandon it. Realize that losses are just a normal part of trading, and not a reason by themselves to abandon a system.
7. Value judgments
Beginning investors tend to attach a value to a stock, sometimes in reference to a recent high or low, but often by referring to their purchase price. If the price of one of your stocks falls, do you now think that it’s ‘cheap’? If a stock you’re considering buying goes up by 5%, has it become ‘too expensive’ for you? The only relevant measure of value is the price – this is what the market thinks the stock is worth. Thinking the market is ‘wrong’ can lead to some expensive mistakes – the market can stay irrational longer than you can stay solvent!
If you can eliminate these 7 deadly sins from your trading, your consistency and profitability should dramatically improve. Happy trading!
Now let me enumerate the 7 Deadly Trading Sins:
1. No trading plan
As Yogi Berra said, “If you don’t know where you’re going, you might wind up someplace else.” How will you know if you are achieving your trading objectives if you haven’t defined them? A plan gives discipline to your trading, and stops you acting on impulse. If you can’t find the time to sit down and write your personal trading plan, you shouldn’t be putting your capital at risk.
2. Underfunding
If you are going to make a serious attempt at learning how to make consistent profits from stocks, you need a reasonable starting capital. Opinions vary as to the exact amount, but I would say you need a minimum of US$20,000. If you have less than this amount, you may be forced to risk a larger percentage of your capital on each trade, and three or four losses in a row could deal you a blow from which it is hard to recover. For example, if you lose 50% of your capital you need to make a 100% return to get back to where you started.
3. Overtrading
As a beginning investor you may feel that you have to be in the market all the time, and feel uncomfortable having your trading capital in cash. However, the fact is that this is often the most sensible place to be. Jessie Livermore, the legendary investor from the early 20th century, said, “It never was my thinking that made the big money for me. It always was my sitting.” So remember patience is a trading virtue - if there’s nothing suitable to do, do nothing!
4. Ignoring stops
Whilst researching this article, I went back to my earliest trading journals to see the most frequent mistakes I made. There was one clear ‘loser’ which cropped up again and again, usually accompanied by capitalized exhortations to myself to ‘ STOP DOING THIS’, and that was ignoring stop losses. If you are a beginning investor, I would be surprised if this is not also a frequent sin for you. The reason it’s so difficult to act on the stop, and sell the stock, is that selling crystallizes the loss and proves you ‘wrong’ – you hope that if you hang on a bit longer the stock may recover. If you do this, you are breaking the cardinal rule of trading, to ‘cut your losses and let your profits run.’ When you can take a loss with the same emotion as taking a profit, you can feel you have made great strides in your learning curve as a trader.
5. Emotion-driven trading
To trade well, you need to be able to concentrate and focus. This means that if, for instance, you’re feeling unwell, or have just had a big argument with your partner, it may be a good idea to put trading on hold for the day. It’s commonly acknowledged that stock trading is driven by two dominant emotions, fear and greed, but there are many other undesirable emotions that may come into play. We’ve already discussed boredom, which may cause you to overtrade. Anger after a trade goes against you may cause you to seek revenge. Pride after a series of wins may convince you to risk more than normal. None of these emotions is helpful to your trading. Be like Star Trek’s character Spock – his imperturbable Vulcan attitude will serve you well!
6. Strategy pinball
Are you still searching for the Holy Grail? Beginning investors tend to believe that there is a secret to profitable trading, and if they can just find that secret the money will roll in. So they try System A, until it produces three or four losses in a row, then they switch to System B, until the same thing happens again. It’s rather like switching checkout lanes at the supermarket – whichever one you pick, the other one always seems to perform better! When you find a system that feels right to you, and that you have back-tested through similar market conditions to confirm that it has an edge, don’t be too quick to abandon it. Realize that losses are just a normal part of trading, and not a reason by themselves to abandon a system.
7. Value judgments
Beginning investors tend to attach a value to a stock, sometimes in reference to a recent high or low, but often by referring to their purchase price. If the price of one of your stocks falls, do you now think that it’s ‘cheap’? If a stock you’re considering buying goes up by 5%, has it become ‘too expensive’ for you? The only relevant measure of value is the price – this is what the market thinks the stock is worth. Thinking the market is ‘wrong’ can lead to some expensive mistakes – the market can stay irrational longer than you can stay solvent!
If you can eliminate these 7 deadly sins from your trading, your consistency and profitability should dramatically improve. Happy trading!
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