Trading Mistakes

One of the goals of this blog is to provide a forum to share my trading successes and failures in hope that others can learn from my mistakes. Bram Stoker, the author of Dracula, said, “We learn from failure, not success!” As a trader, it is imperative that we are continually trying to improve our trading strategy by learning what not to do next time.

I certainly have had my fair share of trading failures and will more than likely continue to have many more bungled trades as time goes on. Hopefully, I won’t continue to make the same mistakes over and over.

I have outlined below some of the biggest challenges I have experienced as a trader. These have been my personal missteps that resulted in significant losses.

  • Trade Size Too Large: This is constantly my biggest challenge. When account sizes are small, it is often necessary to have more at risk on a single trade. However, a single trade should never reduce your buying power by more than 5% of your account size. As your account grows, you want to reduce that amount, not increase it. Ideally, using no more than 1-2% of your account on any given trade insures that even if you have a losing streak, it will not blow up your account. Typically what happens with a new (or even experienced trader) is that you trade small initially and have a certain amount of success and quickly gain confidence. Not satisfied with small profits, you start to step up the trade size significantly and get wiped out. This can sometimes happen even when the trade ultimately would have been profitable. If you are trading naked options and do not keep your trade size in check, a small move of the underlying in the wrong direction can result in huge increases in margin requirements by your broker. If you do not have the ability to maintain that higher margin requirement, you will be forced to close the position and take a loss. Ask me how I know!
  • Scalping/Daytrading Futures: This goes hand in hand with trading too large. The notional value of a single S&P futures contract (/ES) is currently $101,900 (2038 x $50/pt). The initial buying power required to buy or sell a single futures contract is $5,060. Unless you have a very large account, trading in and out of futures is  a fool’s game (and even if you do have a large account, scalping futures is not the best way to utilize your capital). Leverage is a very powerful tool when used properly. The /ES contract offers and incredible 50:1 leverage. In other words, for every point the S&P moves, you make or lose $50. A swift 20 point move in the S&P will result in $1,000 gain or loss very quickly. This is a very quick way to blow up your account.
  • Trading Too Often: Those who watch Tastytrade are familiar with the phrase, “Trade Small, Trade Often.” I absolutely agree with the “trade small” recommendation. On the other hand, I would caution against trading too often.  I am a probabilities trader. In order for the probabilities to work out, you need more occurrences. The more occurrences you have, the more likely the probabilities are to work in your favor.  However, the  probabilities are only going to work in your favor if every trade is placed exercising good judgment and extreme caution. Placing trades just for the sake of getting more occurrences will not result in favorable results. A trade must only be placed when favorable conditions exist for that particular trade.
  • Not Managing Profits and Losses: This is a far-reaching and controversial topic. Some authorities say, “Let your winners run.” Others say, “Manage your winners.”  It is important to manage both your winners and your losers properly.

    In an undefined-risk trade, I will usually close a profitable trade when I have captured 25% of the potential profit in that trade. I used to wait until it was a 50% winner, but have gotten burned in the past letting it ride that long. If an undefined-risk trade becomes unprofitable, you need to have an exit strategy. Some options traders say that you need to stay in the trade and allow the probabilities to work in your favor. When a trade starts to work against me, it is usually in a big way and things go wrong quickly. You must have a plan for adjusting and/or exiting the trade and not just hang in there waiting for a miracle.

    With defined-risk trades, I am willing to stay in the trade longer if it is profitable. Historically, I have closed profitable defined-risk trades when I have captured 50% of the potential profit in the trade. I am experimenting with expanding that value to 75%, but I do not have enough data yet to make a determination whether or not that will end up working for me. If a defined-risk trade works against you, many people will say that you should just hold the trade and allow the probabilities to work out since your risk is already defined. I subscribed to this mentality only to watch many trades go bad and never recover. In trades where the width between the strikes is only a few points, I am willing to let the trade run. However in larger spreads (10 or more points wide), I don’t think this is wise for my trading style.

  • Not Staying Mechanical: I have a trading plan that states how I will enter trades, exit trades and adjust trades. And yet, I find myself in situations where I cannot execute the plan mechanically due to emotions. An example is the crude oil trade that I made earlier this week. It was an undefined-risk trade. My trading plan says to close the trade when I have captured 25% of the potential profit. Yet, when it got to that point, I thought. “I have only been in this trade a few days. I bet I can squeeze a few more bucks out of it if I just stay in another day or two.” Wrong answer. Luckily, I closed the trade yesterday. Today oil was down again and I would have given up all my profits had I stayed in the trade. It is easy to let our emotions get in the way. A good trader learns how to avoid this trap.

This list is not all-inclusive. It focuses on some of the pitfalls that have been problematic for me in the past with my trading and continue to challenge me. If you have other trading failures or pitfalls that you would like to add, please post them in the comments section below.