1. Prepare a Plan and Abide By It
Successful corporate executives and entrepreneurs write business plans for their areas of expertise. Others, who think they know everything they need to know but haven’t planned, tend to fail. Traders need to use the same mindset of successful business leaders when trading. To use Kenny Rogers’ words, good traders know when to hold ‘em, fold ‘em, walk away, and to run. Those traders know in advance how much to invest in a trade and have established caps on potential losses. First-timers often don’t have a plan in place when they start; if they do have a plan, they often don’t stick to it. The key is to have a plan and stick to it.
2. Take Your Lumps And Cut Your Losses
Good traders can accept a small loss; inexperienced traders often refuse to accept defeat. In the process, the latter entrench their righteousness and dig in their heals. Good traders are proactive in cutting their losses, but inexperienced traders cling to a belief where they won’t admit fault to themselves. By not cutting losses, avoiding the inevitable can produce even more losses.
3. Cap Losses
Cutting your losses segues nicely into capping your losses. Implementing caps – and sticking to them – generally prevents losses from getting out of control. One caveat: placing a cap on a long position could result in not letting the long-position run its course. An additional point: traders may cancel their cap immediately before it’s implemented because there is a sense that the losses will stop and reverse course quickly – good traders don’t make this mistake.
4. Reduce Losses By Averaging Down
Averaging down makes sense under certain circumstances. When buying a blue-chip for the long-term – and investing for the long-term is part of your plan – averaging down makes sense. Averaging down in securities of high-risk with a high potential for volatility makes little sense. By purchasing more of a losing position in the hopes of reducing losses, the trader might need cut substantially more losses than if they had avoiding attempting to average down their losses.
5. Use Leverage Appropriately
Leverage is great for traders – if they know how to use it. Leverage used properly can enhance returns; when used poorly, it can exacerbate already losing propositions. By using too much leverage, inexperienced traders can see their investments evaporate quickly. Leverage can be part of a trader’s plan, but experienced traders won’t be tempted by too much of what seems to be a good thing.
6. Churning – Or Excessive Trading– Can Kill Returns
Bad financial advisors have lost their licenses when they churn a client’s account. Traders, on the other hand, only risk their own funds by churning (or overtrading) their portfolios. Excessive trading can be the difference between a profit and a loss. This separates the men from the boys…..or, the good traders from the inexperienced.
7. Bandwagon-Jumping = Buy High & Sell Low
If someone else is doing something, it must make sense, right? Maybe not. Bandwagon-jumping or herd mentality can result in buying high and selling low. This temptation might also encourage the trader to take short positions in securities that are at rock-bottom and might be on the rebound. Knowledgeable traders believe trends are worthy of your attention (after all, there is an investment strategy known as momentum investing), but there is no shame in selling when the crowd is too big. Think 1929. When people whom you never thought would be investing in your stocks, perhaps it’s time to get out. Being a contrarian can be a good thing investing.
8. Do Due Diligence
In business and possibly in life, if someone thinks they know what they’re doing without doing due diligence – i.e. they’re relying on intuition – then it’s a good bet that they don’t know what they’re doing. Due diligence is key to knowing trends, data releases, and trading patterns. Cutting corners by making trades without doing research can result in more losses.
9. Avoid Market-Jumping
The inexperienced in forex may naively jump from market to market. This could entail jumping from stocks markets to others like options, futures and currency markets. Specializing in one market is a far better strategy than octopus mentality – having your tentacles in multiple markets and understanding none of them well.
10. Irrational Risk-Tasking
If inexperienced traders think trading is a get rich quick scheme, they could be in for a rude awakening. Overconfidence and complacency breed problems like irrational risks. Calamities are waiting for traders who engage in such activities.
What can be Learned? Trading Can Be Rewarding
Despite all the potential problems outlined above, trading can be an enjoyable income-generator. The big test for any trader is how to avoid major pitfalls and not to get caught in the quicksand. To make mistakes is to be human; certainly, any trader no matter how experienced will make them. One key difference between successful traders and the unsuccessful is how they respond to mistakes. If traders abide by these ten rules, one can only imagine how successful they might be.