Common Trading Pitfalls

The fastest ways to blow up a trading account are to engage in the Trading Pitfalls listed below:

  1. Chasing a Trade
  2. Alternate State Trading
  3. Adding to a Losing Position (Averaging Down)
  4. Not Using Stops
  5. Always trade with the "major" trend.

Chasing a Trade

Chasing a trade is when a security breaks out and quickly runs higher (or lower in the case of shorts).  You see this.  Your adrenaline starts flowing.  Your heart starts racing and you want to jump on the bandwagon and fear being left out.  Rules be damned.  So, you enter a limit order at the offer/ask.  (This is your first mistake.  You should generally enter your offers at the bid.)  The stock jumps higher and your order goes unfilled.  So, what do you do?  You place a new limit order at the now much higher offer/ask.  Now what happens?  It jumps higher again and your order again goes unfilled.  So now what do you do?  You do the unthinkable.  You enter a market order which naturally is filled.  Then what happens?  The stock initially jumps even higher.  You do a jig and yell Hallelujah!!!  Now you have visions of lavish vacations and new toys.  But then, the stock pauses and crashes even harder and faster than it rose.  Now you are in a world of hurt.  What do you do?  You scream GET ME OUT and you click SELL.

What should you have done when you missed the initial breakout?  One of two things.  Either you should have waited for the stock to retrace to the breakout level.  If it did, then once it turned up again from the retracement, you would have a low risk entry point.  Or you should have walked away and looked for another opportunity.  Those two choices should have been the only ones you should have considered.  Never chase a trade (unless you like getting crushed).  There will always be another opportunity.

Alternate State Trading

This is when you flip flop from long to short or from short to long due to your emotions.  It happens something like this.  You see the perfect long set up, like an inverted head and shoulders pattern that breaks the neckline on heavy volume.  So you buy 1,000 shares.  It initially trades in your direction but then it turns and heads south.  Next it hits your stop, which was placed .05 to .10 cents below the neckline, (You do have a stop don’t you?) and you are out.  You are pissed that the pattern did not work and you lost money.  So you think that since this was a broken pattern, and the stock is going in the direction of the major trend prior to the inverted head and shoulders pattern, that it is a good short candidate.  You also think that shorting it will allow you to get back the money you lost on the previous long trade.  I bet you can guess what happens next.  Usually the stock flies back up through the neck line and you get stopped out again compounding your losses.

Making the short trade was an emotional reaction to the loss suffered on the long trade.  It was not analyzed to determine if it was a high probability set up.  Don’t trade emotionally because you do so at your own peril.

Adding to a Losing Position (Averaging Down)

Never, I repeat NEVER, do this.  Under this scenario, you buy a stock and it starts to drop but doesn’t hit your stop.  It stabilizes and even begins to bounce.  So you believe that if you add to your position you will get back to “breakeven” that much quicker.  I’m sure you know what happens next.  After you added to your position, the head fake is complete and it drops like a rock.  You just broke a cardinal rule of trading and needlessly cost yourself additional capital in the process.  Another scenario is that the bounce continues but doesn’t go high enough for you to get to “breakeven.”  As a result, even though you see the bounce starting to weaken you hold on hoping that you will get back to “breakeven.”  In this scenario, you committed two errors.  You added to your position from a position of weakness not strength and you let an emotion (hope) dictate where (breakeven) you should exit your position.  Control your emotions, don’t let them control you.  Instead, listen to the market and let it tell you when to get in and get out.