My first “retail” trade was placed almost 8 years ago. I placed those first trades thinking I knew it all. I had managed a pretty significant amount of mortgage-based interest rate risk for a large financial institution. How hard can retail trading be? I saw all these retail traders making money – at least according to their emails that filled my inbox! To paraphrase a famous boxer’s quote: “Everyone has a plan until they get punched in the mouth”. Ok so I didn’t get punched in the mouth, but my wallet sure took a bit of beating. Why? Here are my top 5 trading mistakes (yes, it was hard to reduce the list to only 5!)
Mistake #1: Not Realizing that Trading is a Business
Trading is a business – it’s a profession – it’s not a hobby – and I had to learn to treat it as such. Just like any other business, I had to make an investment in education and technology, find a few trusted mentors and advisors and prepare myself for failure. I realized that losses were the cost of doing business and the emotional impact of even small losses could be greater than that of losing a customer in my prior business. Most importantly, it was very naïve (ok stupid) to think I could essentially walk in off the street and be as successful as a professional trader with many, many years of experience and many, many resources. I have a friend who is an incredible contractor; what are the chances I can go to Home Depot, buy a few tools, and add a beautiful room to a house like my buddy with 40 years of experience – slim and none. I had to learn how to respect the profession.
Mistake #2: Not Trading a Portfolio
I started out focusing on individual trades. I thought every trade stood on its own without any relationship to any other trade. Then I found myself in situations where every trade I had on was a loser. How could that be? After some review (and a lot of education), I figured out that I had to manage my overall portfolio of trades not just each individual trade. How much price risk did my overall portfolio have? Was I net short or long? How correlated were the underlying instruments? What were my option greeks? The same investment portfolio management concepts that I learned over many years were directly applicable to my trading.
Mistake #3: Not Trading a Process and a Plan
I started by entering trades and hoping for the best. My approach was to get long this or short that because it “seemed like a good idea”. After a few more losses (and a lot more education), I started to develop a repeatable, documented process to find and evaluate potential trades. The trades I didn’t take became as important to my profitability as the ones I took. The key was developing a complete trade management plan before entering a trade. The trade plan details the exact steps to take if price moves to here or there or volatility spikes or crashes. I quickly discovered that this detailed trade plan started to significantly reduce the emotions tied up in every trade – I quantified my risks and identified in advance what to do each at step along the way. I learned to paper trade if I didn’t have enough experience with a particular type of trade, instrument or underlying to develop a detail trade management plan. As part of this approach, I stopped blindly taking trades that I didn’t completely understand and/or didn’t know how to manage just because they were recommended by a smart trader.
Mistake 4: Trading Too Big
“Go big or go home” didn’t work for me. Trading is all about managing capital. I’m taking too much risk if I commit more than 1% to 5% of my total capital to any trade and more than 35% to 50% of my total capital to my trading portfolio. I may miss out on a few homeruns but for me, trading is all about approaching capital management in a way that ensures I will make it to tomorrow, next week, next month and next year.
Mistake 5: Not Tracking and Analyzing Trades
After I had a been trading for a while, a friend asked me how I was doing. I said I’ve had some good trades and some bad ones. He asked what were the characteristics of the winners and the losers? I said I didn’t know. He said that seemed like a strange response given that when I was a partner in a manufacturing firm, I knew how and why we made money down to the penny. Why didn’t I do the same thing with my trading? How could I find an edge if I wasn’t crunching the numbers? I immediately started tracking and analyzing every trade. It was eye opening and a key component of trading consistency.
Those are my top five, although there are quite a few more! Always paper trade before risking your hard-earned money. And remember – sizing and trade management are much more important than the perfect entry (this is firmly taped to monitor!)