Everyone makes them, most traders have probably been told by someone how to avoid making them and yet investors believe that this is a phenomenon that only happens to other people.
Trading mistakes to avoid
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CFD and spread betting trading mistakes to avoid
The reality is that the vast majority of investors make little or no plan when they start trading and setting a plan and a strategy will help make larger profits and avoid unnecessary losses.
To help you consider the best course of action when trading or just to refresh your memory, below are some of the main mistakes to avoid.
1. Little preparation
So many people start trading without a trading plan, thinking they can beat the market. You need to set out your rules of trading and guiding principles. At least covering major components like methods of trading, method of identifying positions to trade, entry and exit rules, risk management and trading reviews.
Treat your trading like a business.
Have a business plan. Set goals and understand what you want to achieve and answer the following questions:
1) Why are you trading? To make money?
If that is your answer think again. How will you make that money? What percent returns are you expecting? Note that the more money you risk, the higher the potential return but also the higher potential losses. What kind of losses can you stomach? What kind of losses will keep you up at night?
2) What products will you trade? shares? FX? commodities? indices?
Obviously you cannot be an expert in all off these areas so you should really consider which areas you are comfortable trading in. In fact, you should only trade what you know. With a multitude of products available to trade, it is tempting to trade all sorts of products that you may have no experience in at all. So, for example, if you are a regular share trader and want to trade CFDs, then you should trade share CFDs.
3) What are the values of your CFD or Spreadbet contracts?
How are they structured? Did you know that 1 CFD FTSE contract at 7500 is a total exposure of £75,000 and and 10 contracts is £750,000.
2. Not using stop-loss
If you are day trading you may need tighter stop-losses to avoid excess losses. If you are trading more strategically you may need wider or
no stop-losses and smaller positions.
For example, if you by £50,000 of Vodafone on a day trade, you could consider a tighter stop-loss of 2% rather than a 10% stop-loss you
might use if you were buying Vodafone as part of a longer term trade.
3. Over trading
There are two forms of over trading to be aware of, frequency and open positions.
Today there is an abundance of information available to the investor whether received via a newspaper, trading magazine, investor website,
trading signal program/platform or direct from your broker, all creates trading ideas for the investor to consider. You need to remember that you have the choice as to which ideas you will trade and how many. The more you trade the higher the risk, rest assured that there will be more opportunities tomorrow.
A result of trading too often invariably means that investors end up holding too many positions in the hope that they will all eventually make
profit; this distracts you and affects your decision making process and frequently makes your positions unmanageable.
You need to consider how much you will be trading within your trading plan and review your frequency regularly and do not stray too far from your set trading limits.
Over trading is easily done. Ask yourself why you are entering and exiting positions. If you have a formula and rationale then you should stick to it. The emotion of making and losing money may often lead you astray and you may find yourself making it up as you go with little plan behind your trading.
4. Over leverage
One of the biggest benefits of CFDs and Spreadbetting can lead to the costliest mistake. You have the ability to trade large exposure with a small margin requirement, but this does not mean you have to use the maximum that your platform will allow. Profits and losses are amplified to the size (value) of your positions and not the initial margin. Always look at maximum exposure of all of your positions and the potential losses of these positions. The risk warning “Trading using leverage carries a high degree of risk to your capital, and it is possible to lose more than your initial investment.” is given for a reason.
In our opinion over leverage is the biggest killer of CFD and spreadbetting trading accounts.
Let’s look at a scenario:
You have £10,000 in CFD account and you buy 10 FTSE contracts at £10 a point when the FTSE is at 7500. That’s £750,000 of exposure.
If the FTSE drops by 1.30 % (which it does regularly). You will have lost £9,750, almost the entire value of your account. This is a classic case of over leverage. You are not allowing yourself any flexibility for sharp market movements.
5. No trading diary
It is important to keep a trading diary when you are trading.
When you make a trade, record:
Why you bought the share.
Where you read about it.
When did you plan to sell it.
Later, whether you profit on the trade or make a loss, it is important to analyse the trade.
Was it a good share pick?
Did you stick to your plan?
Was the source for the trading tip of value?
Is this a trade that you want to repeat?
All of the answers will help you develop a better trading discipline and improve your trading in the future.
Notably legendary traders like Warren Buffet are merciless with themselves in analysing their trades and accepting responsibility for bad
6. Expensive egos
Do you want to prove yourself right or do you want to make money. No one likes to be proved wrong. In fact, we always think we are right and the market is wrong, but this can be a very expensive habit.
When the market moves against our convictions, we have to face the fact that our assumptions may have been wrong and learn from the trade. Instead, many individuals dump more and more money into a losing trade, convinced that they are right and the market is wrong.
At times like this, it is useful to remember two quotes from John Maynard Keynes:
“Markets can remain irrational a lot longer than you and I can remain solvent.” and “When my information changes, I alter my conclusions. What do you do, sir?”
7. Averaging down
We have all been there. It’s a great stock. We know all about it. It has good fundamentals and a growth story. Now, for some unknown reason
it tumbles down 30%. We buy more because at this price it’s an even better deal and when it bounces back we will be able to make up for the initial loss. Then, the share drops another 20%.
The math relating to getting back to break even may surprise many traders not accustomed to it. If a share drops 20%, you need it to rise by
25% to get back to break-even.
If a share drops 30%, you need it to rise by 43% to break-even. If a share drops 40%, you need it to rise by 67%. And of course if a share drops by 50%, you need it to rise by 100%. How likely is it that a stock, which has just dropped by 50%, is likely to double in value?
Cutting losses early is key to successful trading. Never fall in love with a stock.
8. Long only portfolios
If you only have long positions in your portfolio it is all based around one trading idea that the market will only go up. This long only strategy is high risk; obviously when the whole market goes down all your positions will lose money. You are missing an essential investment tool that allows you to be able to profit from a falling market, hedge your portfolio and have the option to pairs trade. This means varying your portfolio with both long and short positions so that your investments are more balanced. Investors should be aware that in a short position the risks can be very large indeed and are in effect unlimited as the value of an investment could go up ad infinitum.
Long only positions work well in a market that is moving up, however we have seen substantial and sudden drops. When this occurs your losses can accumulate very quickly.
Having short positions in your portfolio can reduce your risk if used properly.
Other defensive strategies include Pairs trades. For example, Let’s say you think Tesco’s price will rise and Sainsbury’s will drop. You could go long Tesco (buy) and go short on Sainsbury (sell). This can take out some of the market risk as you are trading the difference between the two prices.
9. Unrealistic expectations
You will hear of people doubling their money or see adverts claiming you only have to trade for 15 minutes a day and you will no longer have to work.
Anyone can double their money just visit a casino and choose red or black, but the risk is everything you stake. Your trading plan should have set what levels of profit you are trying to achieve and what you are prepared to risk.
This should tell you whether the trade is right. Many clients expect to achieve very high rates of returns. You need to be realistic about what you are trying to achieve. It would be naive for example to expect to generate an income of £2,000 per month from an investment of £10,000.
10. Taking too much risk
CFDs and Spreadbets are high risk and you need to ensure that you manage the risk; this should stem from your trading plan. You should only be trading with what you can afford to lose. Then your rules of trading and guiding principles should be followed when considering:
Exposure, open positions, diversification and leverage. Also use whatever tools your platform provides such as stop losses, guaranteed stop
losses and trailing stop losses.
Always run through your trading plan before you place a trade. Finally if you are risk adverse or do not have funds that you can afford to
lose then CFD or Spreadbetting trading is definitely not for you and you should not consider trading these products.
If however you would like to discuss CFDs or Spreadbetting further withoutany obligation on your part, we would be happy for one of our brokers to provide you with further education.