Day trading is the act of buying and selling a security within a single trading day. It’s usually practiced in the stock market and foreign exchange. Day traders take advantage of market volatility and capitalize on small price movements.
Day trading can be a lucrative business when done properly. But in reality, most beginner traders lose money, and many traders never make a profit before ending their trading career. There are 7 common mistakes you should avoid, in order to become a successful day trader.
Skip paper trading
One common beginner mistake is skipping paper trading and trading real money right away.
Paper trading refers to trading in a simulator with real market data but fake money. It’s an extremely effective way for new traders to get familiarized with the trading platform, get comfortable with executing high frequency stocks trades, and experiment with various trading strategies.
Beginner traders jumping in real trades without proper practice will most certainly start losing money from the beginning. This will likely cut short their trading career without giving them a real chance.
No trading plan
“Every battle is won before it’s ever fought”. The quote from Sun Tzu, who authored the famous work The Art of War, perfectly illustrates how to win the battle of day trading.
Trade planning is crucial for sustainable day trading success. Trading without a plan is like fighting a war without any strategy, the chance of winning is greatly diminished.
Think through and write down the following considerations before each trade:
- Which stocks to observe and trade (your watchlist)?
- Why would you make this trade? Any catalyst or trigger for price movement? (e.g. news event, sec filings, earnings, market trend)
- Which strategies will you apply?
- What is your ideal entry price?
- When to take profit?
- What is the loss you are willing to take if things don’t go your way?
- What is the risk/reward ratio?
- Where is the hard cut off (e.g. daily loss limit)?
Poor risk management
It’s not difficult for beginner traders to earn some quick bucks here and there, but most of them won’t be able to keep the profits over time, simply because of this one reason – poor risk management.
Properly define stop loss for each trade and rigorously follow through will prevent catastrophic drawdowns. It’s also a good idea to set a max daily loss limit. Once that number is hit, you stop trading for the day.
Never put on risks you can not afford, especially when trading on margin.
Adding to a losing trade
Or “catching a falling knife”, can easily turn a small loss into a big loss, and turn a big loss into an irreversible account-ending loss.
Having a clear trading strategy will help reduce the tendency of knife-catching, and clearly defined stop loss will reduce the damage to your account when things don’t go your way.
Not taking profit
When in a winning trade, it’s one thing to let the winners run, and another when not knowing when to take profit.
Being able to let the winners run requires traders to have a good idea of where the target price is, and what they will do when the trend slows, stops or even reverses. On the other hand, not knowing when to take profit or exit a trade will likely reduce the profit potential, or even worse, turn a winner into a loser.
FOMO
FOMO (Fear Of Missing Out) in trading refers to chasing a trade after missing the initial big move, e.g. buying a stock that has already surged up a lot hoping it could go even higher, or shorting a stock that has been beaten down hoping it could go even lower.
This might work when the trend continues after you take a position. But more often than not, extended stock price actions will reverse to the mean, trending against your trade.
Over trade
Over trading is usually caused by the lack of trading plan, impatience, revenge or boredom. It can quickly rack up large amounts of commission, and will most likely result in trading losses due to the lack of strategy or not following the trading plan.
When you feel you are over trading, the best is to stop trading, take a deep breath, review your trading plan and patiently wait for the planned entry signal. If the stock price has moved way beyond the entry point, it might be a good idea to stop for the day instead of force trades.