The four fatal errors that will wipe out your trading account

QuickTrade did an analysis of its traders, and losing traders had these errors in common.
Image: Michael Nagle/Bloomberg

To better understand what separates the successful from the unsuccessful traders, online broker QuickTrade did a deep dive into a sizeable sample of its client base.

What emerged from this should not be surprising to those with years of experience in trading.

Fatal error #1 – Trading too aggressively

This covers a multitude of sins. Traders sit down at their desks, open their laptops, load up the charting software and believe action is needed. They take a trade, often out of boredom.

“This is particularly a problem with novice traders,” says QuickTrade CEO Hardus van Pletsen. “They cannot look at a screen without taking a trade. Successful traders will wait days or even weeks for the correct trade setup. The losing traders are simply trading their capital away without a plan.”

Van Pletsen says novice traders can have early success, where they make giant profits without understanding why they entered the trade in the first place. “Having early success like this can be fatal, because it reinforces bad trading habits. The novice trader has been rewarded for adopting a gambling mentality. Those early successes will later turn into losses, leaving the trader confused and demoralised.”

Entering a trade out of boredom can quickly spiral out of control. Many traders will increase their position sizes as the market goes against them, trying to turn a losing trade into a profitable one. This can quickly erode your capital.

Other traders get dispersed by trading too many financial instruments at the same time – such as going long the euro/USD, shorting the Nasdaq and going long oil. That’s too much to focus on at one time. The news flow on each of these can be contradictory and confusing, so while you might have started out believing oil is in a long-term uptrend, negative economic news out of Europe may prompt you to change your mind about the euro/USD and oil trades.

Rather stick with one or two financial instruments with which you are familiar, and get to know what drives their prices, says Van Pletsen.

Fatal error #2 – No trading plan, so you exit winning trades too early and losing trade too late

Another sign of the novice trader is a trading plan that is subject to change while the trade is unfolding. The best trading plans are simple: such as when the price of the instrument breaks above the 200-day moving average, that signals a buy. That entry can be fine-tuned with technical indicators applied to shorter time frames.

Novice traders find it difficult to wait for the price to cross the 200-day moving average, since it happens relatively infrequently. They will therefore look at a multitude of technical indicators and different time frames which may contradict the trend indicated by the 200-day moving average. That will lead to them doubting their own trading strategy and changing it mid-stream.

“The data is clear on this,” say Van Pletsen. “Successful traders have a relatively simple but clear way of looking at the market, and will only trade when the conditions for entering a trade are established. Losing traders don’t really have a plan, or if they do have one, they will change it. That is fatal, since it leads them to doubt everything they know about the markets.”

In a state of confusion, novice traders will tend to exit a winning trade too early, believing their luck won’t last, and they will hang on to losing trades far longer than they should, believing a reversal in trend is just around the corner.

This, says Van Pletsen, is one of the fastest ways to wipe out a trading account.

Fatal error #3 – Doubting your trading strategy because you lost

Not all trades are going to win. You should expect to lose a certain number of trades, and you can even expect to lose the majority of trades, provided your losses remain small and your wins are fairly substantial.

A lot of traders have developed a preference for certain types of trading, for example, range-bound markets. All markets will enter periods when they trade between fairly predictable boundaries, so traders will short the instrument when it hits the upper boundary, and go long when it hits the lower boundary. This works well as long as the price remains within these boundaries. But then something happens and the financial instrument breaks out of that range.

Experienced traders will place very tight stop-losses just outside the range in case things go wrong. Inexperienced traders will hang onto a losing position in the hope that it will reverse trend, and let those losses compound. They will also doubt their trading strategy instead of congratulating themselves for getting taken out at their stop-loss because they stuck to a working strategy.

Fatal error #4 – Wrong position size

Inexperienced traders enter the market with far too much capital at risk. A good rule of thumb is to risk no more than 2-5% of your total capital on a trade, says Van Pletsen.

“We found that losing traders, because of the gambling mentality, are risking far too much capital on a trade, and even doubling and trebling down on losing trades.

“The successful traders treat this as a business, where capital protection is paramount. They are not over-leveraged, and they do not risk a third or half of their capital on a single trade. They take a far more conservative approach, and trade with long-term goals in mind.”

Brought to you by QuickTrade.

Moneyweb does not endorse any product or service being advertised in sponsored articles on our platform.

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