The Dangers Of Over-Trading

Whether day trading or trading the daily/weekly timeframe, arguably the single biggest mistake that most traders make is Overtrading. It might be forex trading, stock index trading or even option trades. It makes no difference. All but the most experienced traders invariably trade (a) too often and (b) with too poor selection criteria for the positions that they are putting on.

With the advent of online trading, whereby you don’t even need to call your broker, the ability to put on a trade has become as easy as a click of a button. Whilst this is the way that professional bank traders have always operated, at least they have the discipline of working within an environment that has certain performance requirements of them. They also have specific position limits within which they must remain.

The newbie day trader does not, and fails to even realize that Trading is actually a BUSINESS, just like any other. Hence, you need to study Trading in depth, just as you would any other profession.  You need to create systems and processes for everything you do, and approach your trading in a disciplined scientific manner.

Overtrading can be broken down into at least three components, although there may well be more:

(1)    Trading too often

(2)    Trading low quality trades due to having inadequate entry criteria

(3)    Trading positions that are too large with respect to your account size.

Trading too often occurs for a number of reasons. Many traders just like the “action”, without paying enough attention to how effective their trading strategy, or lack of it, really is.  Inexperienced traders may even think that being in the markets all the time is what Trading is all about.  However, that is not the case.  If you are worried that your money is not working for you, then have your broker keep a portion of it in Treasury Bills, or find a broker who pays you interest on your funds.

Sometimes, a trade is placed in reaction to having just taken a loss, and there is the hope of “making it back”.  Sadly, what most often occurs in this instance is that yet another loss takes place. Unless it is part of a definite predetermined strategy, simply putting on a trade after losing, purely in order to try to recoup that loss, is not a wise approach.

Trading low quality setups is extremely common, and not just with beginning traders. It can happen at all levels, even on professional dealing floors.  It almost always occurs when a trader has no established trading methodology. In other words, he/she looks at the market, performs some ad-hoc spur of the moment analysis, and places a trade as a result. Only once the position is active does said trader then have plenty of time to see the contrary indicators to the trade!

It makes excellent trading sense to (a) have pre-determined criteria for entering trades; criteria that you have tested over time and know works, and (b) stick to those pre-established strategies and actually IGNORE the ad-hoc trading opportunities that seemingly appear everywhere. Remember: there are ALWAYS trading opportunities; more than you can ever hope to take advantage of. The key to successful trading is to only take those trades where you know that you have an excellent chance of success.

Trading positions that are too large for your account size is another all too common error. Traders get into this situation when they are overly confident – bordering on arrogance – and have the notion that “real traders” trade in size. It’s not uncommon for beginner traders to lose 20% or more of their entire trading capital in a single trade. This occurs because the trader is not exercising proper risk management, i.e. having a pre-determined strategy with regards to the percentage of total account committed per trade, as well as how losses are to be handled.

Whether you are forex trading, stock trading or option trading, the principle is always the same. You MUST  know  at the time you put on the trade at what point you are going to exit the position if it goes against you. In other words, you need pre-determined stops.  People without them have a tendency to stay with the position because they hate to take a loss, and thereby end up taking a much larger one than they ever expected.

Hand in hand with this, however, is the need to determine in advance exactly what percentage of your account you are willing to risk per trade. Trading legend, W.D. Gann, suggested as much as 10%, on the basis that you would have to be wrong 10 times in order to be wiped out. However, that would be too much for most people. A more sensible level is more like 5%, and a fair number of top traders use just 1%.

Do you see the implications of that? In other words, while inexperienced traders are losing huge chunks of their capital per trade, many seasoned pros are placing tiny positions relative to their total account size; trades as little as 1/100 in some cases!

All of this should give you a lot of food for thought. In summary, in order to avoid overtrading, you want to make sure that you:

(1)    Have a predetermined and tested trading strategy that you know works, from having done statistical testing.

(2)    Risk a predetermined amount per trade, and ensure that it is a SMALL percentage of your total trading capital.

(3)    Trade only when your predetermined signals are hit and ignore all other opportunities until you have rigorously tested them. Do not think you have to be trading all the time.

(4)    Look at as much information as possible when placing your trade, and not just the information that favors what you want to do anyway. Take the Devil’s Advocate position, and seek out and weigh any factors that do NOT support what you want to do.

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