Trading in stocks, stock indices commodities and ETFs is a good opportunity for individuals with a tolerance for risk to earn returns. However, the stock market is an unpredictable space and slip-ups are common, especially for first time traders. Indeed, mistakes are inevitable and an important part of learning. Astute investors will learn from their missteps and those of others. Here are a few common trading mistakes you should avoid.
1. Not having a trading plan/following the herd
Novice investors sometimes approach trade without a plan. They fail to consider their risk appetite, the amount of loss they’re willing to take, entry and exit points, the amount of capital to invest and when, and time horizon. Because there is no underlying strategy informing their trading decisions, they may end up blindly following the herd – a strategy that works until it doesn’t – leading to losses.
All of that can be avoided by simply setting up a trading plan and then investing according to it.
2. Losing sight of risk tolerance
Risk tolerance means the amount of risk you are able to accept comfortably. Investors with a high-risk appetite are willing to take on higher risk if it means they can increase their return whereas low-risk investors will settle for lower interest in favour of protecting their capital.
There is nothing wrong with being in either category – it simply comes down to personal preference and priorities. It only matters that you know your risk appetite. Inexperienced traders invest while focusing on the return and completely fail to consider their risk tolerance. The problem here is that they will make trading decisions with a higher risk implication than they can stomach, or that they’ll be spooked by market volatility and ultimately fail to achieve their investment objectives.
3. Chasing performance
Undoubtedly, you invest to make a return but to make this your only consideration would be a mistake. Picking a certain stock, investment manager or asset class based on its previous strong performance sounds like a wise thing to do, but that is not always the case. There are other factors to consider, such as overall market conditions, industry-specific conditions, price-to-earning ratios, macroeconomic factors, and so much more. Remember, past performance is not a guarantee of future returns.
4. Failing to diversify and rebalance
You’ve heard this many times before. Don’t put all your eggs in one basket. Spreading your capital across multiple, non-related assets limits your exposure because in case one underperforms, that will be offset by others that do well.
Aside from diversifying your portfolio, you should also remember to rebalance it regularly. Over time, some stocks will occupy a larger percentage of your portfolio because they did well. But that also means you are taking on more risk. To mitigate that, rebalance every so often according to your asset allocation strategy.
5. Letting losses accumulate
Making bad trades is inevitable. Even the most experienced investors have made poor decisions or had the market turn against them, resulting in losses. What they do, that amateur traders don’t, is accepting the loss and exiting to limit further loss.
It is advisable to institute a stop-loss order, which is an instruction to sell an asset when it’s price dips to a certain point. This allows the trader to protect their remaining capital in the event that the price continues to decline.
Becoming a successful trader will take time, a willingness to learn from previous experience and persistence. Painstaking though it may be, achieving your investment goals is a worthwhile reward.