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Pitfalls That Line the Day Trader's Path

written by: Steve McFarlane•edited by: Jason C. Chavis•updated: 7/17/2011

From practicing bad risk management to choosing the wrong broker, there seems to be no end in the number of mistakes a day traders can make. By learning how to avoid day trading mistakes, investors can increase their chances at becoming successful and achieve financial freedom.

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    The prospect of making millions from trading the financial markets has always excited would be traders with the possibilities of achieving financial freedom while working whenever and wherever one likes. While many do very well trading stocks, forex and commodities, there is also a large group of traders who consistently lose money or their entire trading capital.

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    Things to Consider

    From over-leveraging one’s trading account to lacking discipline, there are many reasons why traders don’t succeed. Some common mistakes that traders make include the following:

    Bad Risk Management – Many traders would be profitable had they practiced good money management. A good trading strategy allows the trader to make multiple bad trades without wiping out the trading account. It is inevitable that trading losses will be made, how quickly those losses deplete the trading account will, in part, depend on what percentage is risked on each trade.

    For example, if a trader’s money management plan allows for no more than a 2.5%, he would have lost 50% of his trading capital after 28 consecutive bad trades. Similarly, he would lose 50% after 14 consecutive bad trades with a 5% stop loss and also 50% after seven trades if his stop loss is set to 10%. In essence, it is better to risk making smaller losses per trade so one can sustain a longer run of bad trades than to try making a killing and risking one’s entire trading capital. After all, bad runs will inevitably come.

    Being Undercapitalized – Some brokers allow their traders to exchange whatever number of units they desire. However, if a broker only allows trading in standard lot sizes, one must be careful to have enough capital to safely trade the minimum units without overexposing the trading account.

    Day trading mistakes 

    Trading Too Many Instruments - It may be nice to brag to your friends that you trade everything from gold to mutual funds, but denying yourself the advantage of becoming an expert at trading only a few instruments will come to the detriment of your trading account. Whether you trade the forex market, stocks or commodities, you must take the time to understand the variables that move the markets you trade. Not only must you keep tabs on the fundamentals (i.e., earnings reports, general economic data) and technical variables, you must also take time to understand the characteristics of the instruments that you trade. This is why it's better to specialize in trading only a few instruments at any one point in time.

    If you are trading with a long-term horizon in sight you can select multiple instruments and monitor them on a weekly or even monthly basis. However, if your attention is divided, you may leave yourself with too much to consider. You could just as easily put too much on your plate if you trade a single market. For example, actively day trading more than three currency pairs can be just as challenging as trading multiple markets.

    Not Following One’s Trading Plan – If you start your trading journey correctly, you would have prepared yourself by reading all the trading resources you can in order to familiarize yourself with trading terms and jargons, as well as develop and back-test a trading plan. The only thing that is better than simply having a good trading strategy is implementing it successfully. Unfortunately, many traders abandon their trading plans when faced with live market conditions that seem to tempt them to trade on a hunch. It doesn’t matter how good your trading plan is, if you don’t follow it, it is no good.

    Choosing the Wrong Broker – If you are a scalper, you will need a broker that doesn’t charge high fees per trade as this can seriously affect how profitable you can make your trading. For example, if you trade the forex market, look for a broker that offers tight spreads. Similarly, if you won’t be able to spend all day at your trading desk looking at charts, ensure that your new broker offers a mobile trading option.

    Lack of Patience – Lets face it, the market won’t wait until you are at your trading station before it shows you the perfect trade. A good trader is one who has the patience to wait for the right market conditions that are dictated by his trading plan. Be sure to ignore trade setups that don't seem in alignment with your original goals. If a good trade is missed, there is sure to be another good one tomorrow or next week – wait for it.

    Starting to Trade Too Soon – Many are enticed to quickly open a trading account and start their journey toward making millions. Truth is, it takes time to understand the ins and outs of day trading. Never start trading until you have a good trading plan that you have proven with back testing and practice. Before you start trading you will also need to develop a good understanding of trading concepts and prove that you can be profitable while following your trading plan. Using a practice account that mirrors real world trading conditions can be highly beneficial in this situation.

    Trading to Pay the Rent – This is the same as trading under pressure. Trading opportunities won’t present themselves at your convenience at all times, the market doesn’t know or care that you have bills to pay. Unfortunately, quite a few traders will try to find a trading opportunity where no good trade exists – the anxiety that comes with trading to make a living can cause the trader to make bad trades.

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    A Final Word of Caution

    There seems to be no end to the number of day trading mistakes one can make, but you can avoid many by developing a good trading plan. Take the time to educate yourself on how the market works, practicing your trading with a demo account before trading real money. Work on your self discipline and be sure to not pressure yourself to trade when the conditions aren’t right. Start with these basics and you will be on your way to becoming a successful trader.

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    References:

    "Common Mistakes Made While Day Trading," http://www.tradethemarkets.com/public/day-trading.cfm

    Image credit:

    "Day trading mistakes," by artemuestra under Creative Commons 2.0