Stock trading is not a hobby. It’s science. Anyone who thinks otherwise is destined to experience huge losses at some point. Hobbyists tend to have a lack of emotional control. They do everything on impulse because they “feel it in their gut.” That might work once or twice for a trader. In the long run, without a trading plan, it’s a path to failure.
Most of the mistakes that result in stock market losses are directly related to the behavioral biases of the trader. The most dangerous of these is the disposition effect, a tendency to sell early or hold too long. Many traders do this and actually deceive themselves into thinking of it as a solid trading plan, justifying their actions by claiming they are minimizing risk.
Selling a stock before it hits maximum value is fear. Holding on too long is greed. There’s no science behind either and certainly no data to support these actions as valid trading strategies. To correct those behaviors, it’s important to look at the common mistakes that lead to a fear or greed-based mindset. Neither happens naturally. They’ve learned behaviors.
Mistake #1: Trading without a Plan
Newbies will open up a Robinhood account and start trading based on what the Motley Fool or Seeking Alpha tells them to do. They’ll read the Journal or Barron’s and hear about the next big tech stock and how it will make them millions in a few years. They know nothing about volume, liquidity, or Sharpe’s ratio, so they “trade” based on what the media tells them.
This is not a plan. Eventually, the folks who operate like this either fade away and open a safe ETF portfolio at Acorns or they learn and start to look at market indicators and historical graphs. The damage is already done, though. They’ve either taken so many losses that they’re desperate for a gain or they’re gun-shy and jump out of positions too soon.
More experienced traders make this mistake also. It’s not an accident that stock promoters release articles right before the market opens. Their job is to drive investor behaviors. It’s pretty easy to hype a mediocre stock with low trading volume to a desperate audience. If you’re having a bad week, you might just buy into it. Don’t do it. Always have a plan.
Mistake #2: Riding the Imaginary Wave
On June 5th, 2020, the Dow jumped 3.2% to close over 27,000 for the first time since February 25th, the beginning of the Covid-19 pandemic in the United States. I did well because I was invested in several petroleum options that aged out that day, which was a Friday. As an experienced trader, I took my wins and waited out the weekend.
A one-day spike is not a wave. Day traders and scalpers did well on June 5th because they know how to buy on the upslope and sell before the decline. The market jumped after an optimistic jobs report. It moved based on emotion, not market conditions. My options to sell OXY at $16 netted me $320 per contract. The stock was selling at $24.40 a share. Today it’s at $17.66.
Big wins make you want to double down and get more big wins. That’s why casinos and racetracks do well. Real traders, contrary to popular opinion, are not gamblers. If you score a big win on an up-market day, enjoy it, but stick to your original trading plan until you see some real movement. In other words, don’t go “all-in” on what could be a bluff.
Mistake #3: Confusing Loss Aversion with Risk Management
Loss aversion is a fear of loss, not a risk management strategy. When mental accounting starts and you regularly hold positions too long, you may be experiencing a cognitive bias. Tell yourself it’s a long-term plan if you want, but you’re a trader, not an investor. Those positions should have been sold when they first started to decline. That’s how you mitigate losses.
Traders need confidence. Fear should never dictate whether you buy or sell. Unfortunately, loss aversion is psychological, not a learned behavior. That makes it harder to overcome. It also makes it more difficult to detect. That’s why you should always keep a trade journal. Harmful tendencies will eventually reveal themselves if you track all activity.
Another way to offset loss aversion is to set up stop-losses on all trades. You should be doing this anyway. No matter how dedicated you are to watch the market on your computer screen, life will take you away from it at some point. Stop losses automate the selling process for you and give you the freedom to step back. Go to lunch. Take a walk. Enjoy life.
Mistake #4: Punching Above Your Weight
Yes, it’s a boxing expression. It’s also a life metaphor for people who try to do something they’re not capable of. In your case, that’s trading large positions when you have limited equity. Sadly, this is a common mistake among traders. You see that Tesla is moving, so you buy a huge block of it. Then you watch it go down like a failed rocket launch the next day.
Is Tesla a bad investment? Absolutely not. But you’re a trader, not an investor. Dumping all your equity into a large position will leave you paralyzed. It goes against the root concept of trading. Your success is dependent on constant movement in and out of trades. Betting everything on just one trade is simply not smart. You could lose everything.
Start small. If you’re new to the trading world, buy small positions and experiment with risk management strategies. Evaluate charts and graphs. Use a simulator to test your trading plan so you don’t lose any money. Tickeron’s Paper Trade application is one of the best available for this.
Mistake #5: Buying into the Hype
Do you know how stock promoters make money? It’s not from the pop-up ads on their blog. Stock promoters make money off your behaviors. They hype up a stock, hoping to increase trading volume and drive up the price. Then they sell when the stock hits a peak, driving the price back down and taking a chunk out of your trade balance.
They are predators. Don’t be a victim. Successful traders make decisions based on technical and fundamental analysis, not media hype. When you lose sight of that, you’re setting yourself up for a loss. Jim Cramer doesn’t care if you make money. He has his own portfolio. When Jim gets out there and honks his horn, he’s looking to move the market for his benefit, not yours.
Stick to market trends, historical analysis, charts, patterns, and statistics. Take advantage of optimized pattern and trend search engine tools at Tickeron to find winning stocks. The nonsense being spouted by stock promoters is nothing more than background noise. If you want proof of that, put one of their “sure things” on a watch list for a few weeks. You might see a small spike that corresponds with their big “announcement,” but it will likely be a blip, followed by a big dip.
Understanding and Overcoming Behavioral Bias
Every human defect of character or shortcoming is based on fear. If you’re suffering from a behavioral bias, you’re not defective. You’re just human. The bias is likely viewed by your subconscious as a self-protection mechanism. Combat this by becoming conscious of the problem and seeking ways to overcome it. Here are some examples:
Representative Bias: Day traders sometimes make snap judgments based on past experiences. This can be an asset, but it can also become a destructive pattern. Condition yourself to treat every trade autonomously. Use your tools.
Cognitive Dissonance: You’re likely a Type A personality. Most traders are. Cognitive dissonance is the bias that makes you incapable of seeing an opposing viewpoint. You’re convinced that you’re right. Train your brain to be open to new ideas.
Home Country Bias: Nationalism is not a profitable business model, for you as a trader or for your nation. Stock trading is a global profession. Don’t listen to the politicians on this. If you can make money on Alibaba, buy it. The country of origin doesn’t matter.
Mood Bias: If you’re pessimistic and always expect underperformance, you’ll struggle as a trader. Optimists who believe losses will always turn to gains if you wait long enough will just take bigger losses. Find a balance. Better yet, leave your feelings at the door.
Attachment Bias: Green is the only color that matters to a trader. It has no political affiliation, religion, or country of origin. It doesn’t care if you drill for oil or drive an electric car. If any of these affect your trading decisions, you’re in the wrong business.
Practice Makes Perfect
Okay, you’ll never be perfect, but if you practice on a simulator before jumping into live trading, you’ll have more good days than bad days. Tickeron’s Paper Trade simulator allows traders to discover their own strategies and sharpen trading skills, time management, and emotional control before trading with real money. You can learn more about it here.