HOW TO AVOID BLOWING UP IN THE STOCK MARKET

HOW TO AVOID BLOWING UP IN THE STOCK MARKET

The person you most have to fear in trading is yourself. You can be your own worst enemy when trading if you don’t have dedication and a willingness to learn. Nothing can be as expensive as learning to play the stock market when you don’t know what you are doing.

Here are some of the mistake. Some of the common reasons why beginner traders usually lose at the first attempt. Try and avoid them all costs.

Never Trade Blind

This first one seems like a no-brainer but you would be surprised at the number of people who try play the stock market each year without having the sense to learn a thing about it.

The stock market can be to just jump in and learn by doing. But those without a good system. There are few professions that are as expensive to learn as trading, so before you begin, equip yourself with the best tools, the best knowledge and the best techniques.

Similarly, never blindly follow advice or a tip from someone else. Your neighbor may truly believe that Texas Instruments is about to triple next week but it you haven’t done your own research it’s unlikely you have the confidence to sit with the trade once you have put it on.

Never Trade by Emotion

We have all experienced the emotions of greed, fear or hope. These emotions rule in the stock market even today. A piece of advice – when it comes to playing markets, the best time to buy is when people are fearful and to sell when others are greedy. It is a good, timeless piece of advice, because it goes against human nature and works more times than not.

Indeed, if you often change your position as soon as you have put it on, or sometimes do not have the courage to put on a position (instead, waiting until it is too late), then you are probably trading out of fear. Systems can be an excellent way of combating these problems.

Similarly, if you often add to winning positions hoping to win even more, or jump in the market at any opportunity, you are probably trading with greed.

Don’t worry, it’s only human and we have all been there. Do your best to conquer these emotions and you can be well on your way to trading profitably.

Never invest all your Capital into One thing

This one seems like common sense too but is something I was guilty of back in the beginning. If the last few year have taught us anything, it’s that even so-called safe investment, like saving accounts, are not always completely secure. If that can be said about a bank, think about how unsafe it is to put all your money on a short-term trade.

Investment should be spread over a portfolio of different securities, so if one fails you do not lose all your money. Diversification could include bonds, currencies, precious metals, short positions or simply different stocks. If you are into shorter-term trading or investing, a good rule of thumb is to invest less than 2% per investment with an exposure of no more than 25% of your capital.

Also, you should never trade with money you can’t afford to lose. You are likely to make all sorts of bad decisions and put your credit rating under threat.

Never overtrade

Investing all your money into one thing can also be called overtrading. It’s risking too much capital on any one position and, quite simply, it means that one bad trade can result in losses big enough to wipe out an entire account.

The second definition of overtrading is jumping in and out of the market too many times in an attempt to catch lots of short-term moves or because you are undecided.

The problem is that the commissions for each trade significantly eat into profits and destroy your chances. Trading is not a zero-sum game, because each time you trade you are paying the spread to your broker. If you make too many trades, you are effectively gambling and the commissions will destroy you.

Again, I was guilty of this problem at the beginning, largely because I didn’t really know what I was doing. Once you develop a strategy that you feel confident with, the problems of overtrading tend to disappear.

Never follow tips

While it can be good practice to listen to what the experts are saying about markets it is generally not such a good idea to trade like them.

The problem with following someone else’s advice is that when the trade turns sour you most likely won’t have the confidence to stay in the trade. Successful traders rely on their own research and strategies that are aligned with their own risk appetite. That way, they always hold themselves responsible for taking trades and this fosters a much healthier attitude towards trading.

Another reason for not listening to someone else’s trading picks is that they rarely give you all the information. The tipster may well have hedged his bet with some other trade, or they may have a take-profit target that they haven’t disclosed.

Even worse, they may have a conflict of interest, such as a broker who wants you to buy a certain stock so that they receive commission for the sale.

In general, brokers are salesmen and are not the best people to listen to when making trading calls. If they were any good at trading, they would probably be running hedge funds and not working as brokers.

Never place stops randomly

Markets can go in any direction, so without stops the possible downside to your investment can be limitless. That’s why many successful traders use stops in the market to limit the possible downside to their investments. Many traders find that stops need to be kept super tight in order to manage risk effectively.

However, other traders find that stops can destroy their strategies if they are placed too close to the action. They therefore place their stops far away and use other rationale to exit their trades.

The best solutions are to test your strategy to find out where the best place to put your stops is and to never enter them into markets randomly.

Never fight the trend

All good traders know the best way to trade in markets is to follow trends. Going against the tide can sometimes offer big rewards but it requires patience and, more often than not, it is a losing strategy in the long run. Indeed, if you look through history, most successful traders have been those who have gone with the trend. The best advice is therefore to ride winners and cut losers quickly.

Traders who try to go against the trend usually end up running out of money pretty quickly. Victor Niederhoffer is one example of a great trader who went against the trend, but evens Niederhoffer ultimately experienced more than one period of bankruptcy in his career.

Never trade without a Plan

It can take a bit more work but to trade the markets successfully it is vitally important to have a plan of action in place, so you know exactly what to do when things go wrong (or right). Each trade should have at the very least an entry and exit target, a stop loss points and a good reason for making the trade in the first place.

It’s importance to look at the current situation and imagine what happen if markets were to change. What would happen to your investment if war broke out or the Fed raised interest rates? What would happen if oil went to $105 a barrel? Understand what could happen to your investment under different scenarios and plan what you would do when those scenarios play out.

Never trade the Unknown

Many traders and investors are successful, not because they have some innate ability to time markets, but because they specialize in one or two areas and learn them inside and out. Indeed, there is no shame in concentrating on your area of interest, you don’t always need to be able to trade every market under the sun.

Be it oil, gas, real estate, gold miners or biotech’s, focusing on one or two areas is one of the best ways to prosper. Concentrate on what you know and you can have an edge over 99% of the rest of the markets, which in reality is all you need.

Never ignore money management

Money management is the key to successful investing. Period. In fact, excellent money management can be the difference between a profitable and a losing strategy.

Never Gamble

Trading is not the same as playing roulette or blackjack. It is possible to make big money but only if you take a professional and disciplined approach at all times.

That means trending it as a full-time job and never chasing profits, never overtrading or risking it all on one trade. Trading on the basis of a whim or an emotion is akin to gambling and only ends up losing you money in the long run. Always remember, trading is not strictly a zero-sum game – due to the commissions you pay every time you trade. So, make sure you don’t fall into the trap of trading for fun. It’s a good idea to set up a separate bank account for your trading ventures and treat it as a business.

Study your performance

It seems like a no-brainer but the majority of traders are too lazy to do this one. Simply, if you want to improve your trading, it is essential to study your performance. Keep track of your performance objectively by keeping a diary or spreadsheet of every trade you make, including such things as stop loss levels and charts if necessary.

If all that sounds like too much hard work, contact your broker and have them send over your monthly statements for analysis. Once you have ‘real’ stats in front of you, you can then set about seeing which areas you do well in and which ones need work.

Maybe you set your stops too tight, or maybe you become too fearful ahead of news releases. Work on those weaknesses and you can come out ahead of the traders out there who fail to learn from their mistakes.

Back-test/paper trade

One possible way to succeed in trading is to try and automate as much of the trading process as you can. That way, you automatically rid yourself of having to deal with the common pitfalls of emotional-based trading, such as fear or greed.

Furthermore, if you are able to come up with a strategy with fixed rules and objective goals, you can back-test the idea on historical data and see what would have happened if you had put the system into action. This way, you can test hundreds of different trading ideas without having to lose a penny. Similarly, it is essential to trade your strategy on paper first, before you put any real money at stake. If you can’t make money paper trading, then you certainly won’t be able to succeed when it’s real money.

Have enough capital

Too many traders make the mistake of entering markets undercapitalized, which puts them at a disadvantage at the very start. Due to the volatility and inherent risk involved in trading, it is important to trade small, especially when you are just getting started and that means having an account big enough for you do so.

Most traders recommend putting only 1-2% of trading capital at risk on any one trade. It is sound advice, since there are always opportunities and if you trade conservatively enough, even if you lose money. You still live to fight another day.

Choose your Broker wisely

There are lots of brokers out there and some are better than others. It is, therefore, imperative to seek out a broker that is honest, reliable and one that best suits your needs. If you are a scalper, you may need an electronic communication network (ECN) broker with ultra-tight spreads. Or, if the spread does not affect your margins as much, you may want to go for a broker that excels in other areas such as in back-testing or MetaTrader compatibility. Most brokers provide demos now, so you can try out their services for free.

Learn all you can

It stands to reason that the world’s wealthiest traders did not get there through luck alone. They got there by learning and studying the craft over many years and they have also studied themselves.

So always do your homework; read the best books, the best blogs and try as many things as you can to improve yourself and your trading skill.

Learn about fundamentals, interest rate differentials, the world economies technical indicators, trading systems, price action and, most importantly, learn about sound money management. The cost of successful trading is not just the financial capital you put at risk but the time and effort that goes into perfecting the art.

Don’t lose heart

Although it is painful and you should do everything you can to avoid it, if you do happen to blow your account on your first attempt, consider it as an education and do not beat yourself up over it. Many of the best traders in the world have blown up several times in their careers so don’t lose heart. Take a look through the book, Market Wizards by Jack Schwager, and you realize that one or two blow-ups is actually the norm, rather than the exception for most traders. The most important thing is to learn from the process and come out as a better trader. It’s much better to blow your account early on in your trading career than later on when you are managing millions of dollars.

This Article is taken from How to Beat Wall Street.

Written by Arshad. A

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