Top 10 trading mistakes

July 31, 2009 07:00 PM

Given that many new futures accounts end up busting out, starting out in trading can be a scary concept. However, because many of the same mistakes are to blame, knowing what not to do in trading is a major part of the battle. Here are 10 mistakes to avoid.

#1: Skipping research. Research is always the first step in trading. You need to understand the futures contract you’re trading – tick size, how it is quoted and its normal daily range. Learn and factor into your trading schedule important economic release dates that will affect the market. Exchange Web sites offer education centers with product guides and free webinars. National Futures Association (NFA) offers free one-hour online courses on trading and guides on how to compute the cost of trading futures. And the new features educational resources for new and developing traders.

#2: Not having a trading plan. You should never trade without a plan. Know how much capital you’re prepared to risk. Then, decide on and stick to a trading style.

Jeff Quinto, trading coach for, says that consistency is the most important part of a trading plan. “People often try to find the perfect setup and the perfect idea, and you don’t need to. What you need to find is something that has an edge that you can exploit repeatedly. As long as you make your losses small and you let your profits run, you’ll be successful,” he says.

Larry Szczech, CEO, RJO Futures, says it’s harder to learn from your mistakes if you’re changing your approach all the time. “If you don’t have a plan or know what your profit goals are or how much you’re willing to lose, you’re going to fail,” he says.

Mark Frey, vice president for forex trading at Custom House, says that while sticking to one style can be beneficial, you need to evaluate your model on a regular basis. “Being completely entrenched in your view and not being open to new ideas is a problem as well,” he says.

One aspect of planning is practice. Before you dive in, you should be able to profit consistently in a simulated environment. CME Group’s Web site has links to trading simulators at various brokers. When using a trading simulator, rather than just focusing on winning and losing trades, look at percentage of winners, average winning trades and average losing trades to help measure your success.

#3: Picking the wrong broker. Your broker can be the most important person in your trading life. Learn as much as you can about your broker by performing background checks. NFA’s BASIC search shows futures-related regulatory and non-regulatory actions contributed by NFA, the Commodity Futures Trading Commission and U.S. futures exchanges. Communicate your trading goals to your broker so that you’re on the same page. Don’t listen to brokers who tell you trading is easy or that it will make you a millionaire overnight.

Remember that due diligence is not just about making sure your broker is not a crook but matching the broker’s services with your needs as a trader. This includes electronic platforms and software.

#4: Not doing due diligence. In the midst of Ponzi-scheme mania, doing due diligence is more important than ever. Know where your trades are being cleared and make sure your broker’s clearing firm is in good standing at the exchanges. Make sure your broker uses fast, reliable software and understand all commissions and fees. It’s also a good idea to talk to customers of the firm and find out what it does well and what it struggles with.

“You have to do your homework on several levels,” Szczech says. “On the brokerage firm you’re working with, on the trading tools you’re using [and] on the vehicle you’re investing in. If you don’t want to learn, make that part of your plan and work with an advisor, someone who’s going to do that due diligence for you.”

Frey says to be careful of new funds. “Unless you have a name behind you and a track record, you’re not going to be able to attract investment capital with just an idea. You have to demonstrate that your idea has worked over a period of time by backtesting it,” he says.

#5: Not managing risk. Managing risk has always been a major part of futures trading. First, you have to make sure you have sufficient risk capital to trade. “The more risk capital you have available, the more likely you’ll be able to weather the market volatility and survive to see profitable trades,” says Brian Dolan, chief currency strategist for GAIN Capital.

Even the best systems will get cold and produce consecutive losing trades. Don’t be in a position where a half dozen losing trades in a row will bust you or cause you to reduce your average trade size.

Discipline is a huge part of risk management. “People get on a hot streak and throw the rule book out the window. To be successful over the long haul, you have to take a more disciplined approach, not let your emotions rule you,” Frey says.

Dolan says that once you put the position on, “you’ve got to kiss the money good-bye. For your own sanity, you have to assume you’re going to lose.” He says it’s important to avoid overtrading, either trading too large a position relative to the amount of margin capital you have available or trading too many positions that add up to too large a position for your risk capital, or trading too frequently.

“If you’re going to invest in something that’s highly leveraged like futures, it should always be with risk capital, money you can afford to lose for the potential of higher returns,” Szczech says.

#6: Not preserving capital. Experts agree that one of the biggest rookie trading mistakes is letting losing trades run too long and cutting winning trades short. Naturally, you want to let your gains run as much as possible and cut your losses as quickly as possible.

“Nine times out of 10 you’re better off taking your losses and going back to making money. Rather than trying to work your position back to even, take your lumps and just go back to making money. Forget about the money you lost and go back to rebuilding your book,” Frey says.

#7: Not placing stops. Stop placement (see “STOP the bleeding,” Futures, June 2009) is a major part of preserving capital and risk management. A stop is a buy order above the market or a sell order below the market which automatically becomes a market order when the “stop price” is touched in the market. It’s a spot where you can determine the maximum amount you can lose on a particular trade if the market moves against you. It is best to have this set in advance before the emotions of the market tempt you to lose discipline. Dolan advises protecting your profits by using trailing stop losses or moving stop losses in the direction of the trade. “We don’t call it taking profit for nothing — the market doesn’t give you profit, you’ve got to take it. If you don’t, the market will take it back from you.”

#8: Not diversifying. Keep some variety in your portfolio. Not putting all of your money into one trade or asset class allows you to spread out your risk. “If we’re talking to an investor who’s looking to diversify their portfolio, we would never put them at more than 10% of their investment portfolio in futures because that would be putting too much of your capital at risk in this market segment,” Szczech says.

#9: Ignoring open interest and volume. Pay attention to volume and open interest in the market you’re trading. It’s better for newer traders to trade where there’s more open interest because it allows for a more even playing field. As a beginner you should be trading only in liquid markets at the most liquid times.

“If there are more participants in the market, it’s more likely that someone will be on the other side of the trade. The more participants, the more likely you’ll find someone who wants to trade with you at the price you want to trade,” Szczech says.

#10: Lack of discipline. Many of the aforementioned mistakes can be traced to a lack of discipline. When you start trading, it’s important to set specific goals, research and educate yourself, manage your risk and keep your emotions in check.

“Discipline really means dealing with a highly stressed emotional state caused by the risk of financial loss,” Dolan says. That is why it is important to have a plan to deal with different scenarios before you are faced with them under stressful market conditions.

Be honest with yourself about how much time you can devote to trading. “Too many people think they’re self-directed and they can do it on their own and they’re not willing to commit the time. They find that out the hard way by losing money,” Szczech says. “It’s easy to get lucky on your first trade or two, and it’s the worst thing that can happen because you get overconfident. Overconfidence is a huge mistake.”

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