Evaluating Common Trading Mistakes and their Probable Solutions
Previously, we have covered the different trading styles followed by active traders & passive traders. However, there are common trading mistakes that every trader encounters, which we will discuss in this section and also try to provide a probable solution for each. So let us begin:
1. One blowout trade wiping out all your previous wins:
It is often said that 20% of the trades cause 80% of the losses – so it is about controlling those 20% of losses. This can be done by keeping your psychology strong and staying true to your strategy and plans. The more you get rid of impulse, the lesser will be the percentage of the losses caused by these 20% trades.
2. Failing to admit that you have made a wrong trade or used a wrong strategy:
Own experience: I personally bought SAIL at ₹90 in 2018 based on the news that SAIL will expedite its modernisation and expansion plan. However, like most PSUs, this elaborate plan kept being delayed and the stock kept falling. When my investment had fallen by 20%, I felt that now it is too late for me to book my losses, might as well wait for a reversal and will exit at breakeven. However, I never got that opportunity and SAIL’s stock price went as low as ₹30 in mid-2019.
Learning: We must accept our mistakes and not wait for a miracle in hopes of reversing our mistakes. Once we do realise our mistake, the next course of action should be to bear in the current losses because waiting for a reversal will only enhance the magnitude of those losses. Averaging down is the worst possible strategy one can apply. In fact, what one must apply is the Pyramiding strategy wherein one adds to their existing trade position when the stock is moving in a favourable direction i.e., when you have bought a stock and it starts moving upwards, at every level, we should keep buying but in smaller quantities each time so as to not increase our exposure by a very large extent.
3. Increasing your exposure to a beaten down stock so as to reduce your average buy price:
Own experience: Late 2018, I bought more of SAIL at ₹60 thinking that I will cut my overall losses by earning quick profit trading in this ₹60 lot of the stock.
Evaluation: Human nature doesn’t allow you to accept losses. You keep trying to undo your mistakes by making more mistakes and this is why you tend to go for more aggressive strategies (similar to the one elucidated above) once you start losing.
Probable Solution: The only solution is to set strict mental limits; in this case, in the form of stop losses. Also, one must never take a trading decision incentivised by covering losses, their trading decisions should be only based on their strategy and belief, not hoping for mere luck to be on their side.
4. Taking market exposures bigger than your capacity’s allowance:
Some people treat stock markets as “gambling” or “easy money”. They put all their money on one or two stocks (perhaps based on “tips”) expecting to become a millionaire after that. This is a major problem. Stock market will reward only those who exhibit patience, discipline and skill. A combination of all three is necessary to make money. There is no easy money – even if you make money on one trade based on sheer luck, you will lose it in the next one just how a gambler does in a game of roulette. Money management is a very big aspect of this discipline. One must trade with only that proportion of their income that they can afford losing and keeping stringent stop losses is imperative to continue in the market for the long term.
5. Stopped trading after suffering losses on recent trades:
Profit and losses are part of the game. One must treat them as inevitable outcomes. Losses are not always a result of poor strategies or incompetence, but sometimes just a market phenomenon - a result of the market’s trend. Hence, it is important to not get dejected and continue modifying one’s own strategies to achieve maximum accuracy. If one sticks to their exposure limit and stop losses, they won’t ever find the need to stop trading altogether.
6. Unable to stick to a sound strategy because the last few trades made losses:
This happens due to lack of confidence and is very natural. However, this can be overcome with more and more experience. When you are starting off in the market or testing new strategies, either take smaller exposures or have a smaller cap on losses (i.e., set conservative stop losses). This enables you to test out your strategies and realise even in profitable trades whether the strategy worked on account of being effective or whether it was sheer dumb luck. Once you have established this, it is easier to have faith in your strategy even after a number of consecutive failed trades. This is a calculated (higher probability) loss reversal strategy and not one based on “hope” and “luck”.