Friday, February 17, 2012

Overtrading

The biggest problem I see for new or inexperienced traders is not so much the basic trading strategy they choose to employ, but either trading too often if an intraday system, and/or with too much capital risked on each trade.

Part of the reason for this is that a lot of people go to free seminars or visit websites whereby people promise untold riches for very little effort, with pictures of large houses, expensive cars and exotic holiday locations. You can be sure that yes, traders can and do reach that level where their disposable income allows them to indulge in such luxuries, however to get there they will have employed strict risk parameters with regard to their trading activities. New traders see only the potential gains, not the losses that can easily be racked up.

For those with small pots of money, this problem of overtrading can be an issue if trading more than one instrument at a time, however you need to resist the urge to trade too often. It is for this reason that a lot of successful day traders use the 3 strikes and your out principle - if you have 3 losses, take the rest of the day off. This way it prevents you from trading emotionally in an attempt to recoup your losses, which can potentially lead to totally irrational trades, trying to 'force' the issue. For longer term traders or trend followers, you need to ensure that you do not plunge into too many trades, too quickly. If a meaningful trend develops, then there will be plenty of time to enter good looking set ups. Particularly in a volatile general market environment, this will help avoid a short sharp drawdown in the event of a quick reversal of trend.

In my opinion, the best way to proceed is to learn a trading strategy that has positive expectancy, and to use proper risk management. It is far better to get the building blocks in place at the beginning, rather than make these basic mistakes (which can make you blow up and destroy your trading account) and use the power of compounding to increase your position size as you progress.

Trading is a marathon, not a sprint. It is simple, but not easy. Trading capital is your livelihood, and your first thought on each trade should be to quantify your risk. If you doubt me, then flick through a book like Market Wizards and see how many of these famous traders talk about controlling risk as their main goal. In nearly all the interviews, they talk about their big losses which was when risk got out of control. Control the losses, and the gains take care of themselves.

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