Most beginning traders go through tough times. While there are no reliable published statistics out there, the old Wall Street adage states that “90% of all traders fail.”
If you don’t want to be a part of that vast majority of failures, avoid these three common mistakes:
Taking positions that are too large
Every new trader wants to be an overnight success, but being patient and only trading setups that work best for your style of trading is crucial.
One hallmark of impatience is putting too much money at stake in any one trade.
How much is “too much” depends on the size of your account, but a good rule of thumb is to not risk more than 1 percent of your trading capital on any one position, while allocating no more than 10 percent of your capital to one position. Thus, if you had a $5,000 trading account, you wouldn’t want to allocate more than $500 to any one security, and you would not want to risk more than $50 in any position.
Failing to have a trading plan
Experienced, successful traders get into trades in which they know and can define their edge, and where they can plan exact entry and exit points, as well as the amount of capital they’ll put to work. Moreover, they know the maximum drawdown they’re willing to accept.
Most beginning traders don’t have a clear plan and can’t define their edge, so they’re “trading blind.”
With your trading style and strategy clearly defined, stick to what you do best and ride that style until you have it down pat, learning from mistakes rather than feeling burned by them. Many newcomers start switching strategies — especially when they face adversity — which simply makes the learning curve steeper. When you shift your strategies multiple times, it’s hard to get a good grasp and understand the workings of any trading style. Therefore, stick to one strategy at first, start generating profits only branch into other strategies when they are a sensible, logical extension of your trading activities.
These aren’t the only common pitfalls out there, just some of the most important. Trading is difficult, but if you remain disciplined and avoid these traps, it will get both easier and more profitable.
Jeff Bishop is lead trader at TopStockPicks.com. He runs short-term trading strategies, using stocks, options and leveraged ETFs.