The world of day trading has extremely few barriers to entry, meaning any person with an internet connection, a computer or a smartphone, and a bit of startup capital can theoretically become a day trader.
Many jump into day trading, hoping to earn profits quickly and with minimal effort.
However, reality makes its adjustments, and a new trader may soon be upset with this form of market speculation.
Why is this happening? What mistakes must be avoided?
Just like any other form of trading, day trading should be done based on sound principles and practices that all traders, particularly the newbies, must follow.
In this post, we’ll cover the basics of day trading and discuss some of the most common mistakes to avoid when engaging in this kind of activity:
What is day trading?
Day trading is a stock market term that describes any trading strategy that involves the opening and closing of trades within the same trading session or day.
Day traders utilize technical analysis tools when placing trades, and also have to observe certain rules like pattern day trading (PDT) rules and settlement dates. A day trader may hold positions for a few minutes or hours, but can’t hold overnight positions when using day trading buying power.
The goal of a day trader is to make a profit in the next few minutes or hours based on price fluctuations.
Let’s now take a look at some common mistakes made by day traders that you should avoid at all costs.
Starting without practicing on a paper trading account
One of the biggest mistakes new day traders make is putting their hard-earned money in the stock market without testing out their strategies and learning about the market.
Like it or not, paper trading can help you avoid this mistake and increase the chances of your success when trading real money.
Paper trading is a simulated market environment that allows you to practice buying or selling stocks without risking any real money.
It is a good way to learn how to trade stocks and many other assets, including options, bonds, exchange-traded funds (ETFs), and currencies.
Every new trader should start out in a simulator until they have proven they can consistently make money.
Trading without a trading plan
Having a consistent plan is important for achieving success as a day trader. Day trading is not a cakewalk.
Some traders usually jump into the market without a plan. As a result, they lack guidance on when to make a trade, when to cut losses, when to book profit, and where other opportunities exist in the market.
A good trading plan provides a roadmap on how and when to make trading decisions.
It’s like Google Maps or a GPS device. You indicate where you want to go and it then finds your current location and shows you how to reach where you want to go.
With a trading plan, a trader can also avoid making bad decisions during an emotional moment. It lays out all the criteria that you must meet before you make any trading decision. This is huge when you are in the heat of the moment and need to make smart decisions quickly.
Instead of having to move on the fly, you can fall back on your trading plan that you put together when time wasn’t an issue.
Trading without a journal
Any serious trader who wishes to make money has to keep a trading journal to help them evaluate themselves objectively and hold themselves accountable for their actions.
Recording the details of your trades in a journal allows you to see the trades in black and white, instead of just relying on your ability to remember.
A trading journal helps you track your trades and thoughts throughout the day. It is a fantastic tool because it includes details such as what market conditions were like and whether you made mistakes or were distracted. It is also where you can record strategy ideas that may come up as you place trades throughout the day.
To capture what was happening and why, use screenshots of your daily trading charts with typed annotations instead of a handwritten journal. Store these screenshots in organized folders on your computer, so you can review your trading history and make adjustments where necessary.
Following the crowd
Following the crowd or the herd is the simple strategy of trading what most people are trading. This could involve shorting stocks that everyone is shorting and buying those that most people are buying.
The problem with this is you are leaving the decision making up to someone else. It’s best to understand which stocks everyone is trading, what we call stocks in play, and then build your own trade plan around that.
Using high levels of leverage
Leverage involves borrowing money from your broker in order to buy more shares than you would normally with your cash. Every time you use leverage, you are using debt and your balance serves as collateral.
One of the main reasons why day traders use leverage is that it can increase returns (as well as loses). This can be immensely useful during periods of low volatility where price movement might not be big enough to yield meaningful returns.
But as alluring as it is, leverage is best used in small doses and sporadically. Even though amplified returns can be tempting, leverage can also exacerbate losses on losing trades and has been a ruin of many successful traders who got carried away.
Adding to a losing position
Never add to a losing position!
A trader stays in a losing position either because they don’t want to lose money on the trade or they don’t want to be wrong about the market. Regardless of the reason, it causes them to stay in positions that are going against them.
When you are in a losing position, the market is telling you that you are wrong. If you continue to hold onto a losing position after the market tells you that you are wrong, you are basically saying you are right, and the rest of the market is wrong.
If you add to a losing trade and it fails to work in your favor, you could end up blowing your account, particularly when using leverage. Therefore, if the market moves against your position, particularly for a prolonged period of time, it is advisable to take a loss and move on.
Risking more money than they can afford to lose
In the stock market, some people are drawn to the idea of earning a life-changing fortune by being at the right place at the right time. Consequently, they go all-in on stocks, risking more money than they can afford to lose.
Doing this could blow up your trading account, leaving you to either close the account or add funds. How much capital a day trader risks depends on the size of their account. As a general rule, you shouldn’t risk more than 1-2% of your account on a single trade.
Trading with technical indicators and patterns that are not well understood
Chart patterns and indicators are widely used to make trading decisions.
From beginner traders to professionals, patterns and indicators play a crucial role when predicting movements and looking for market trends. They can be used to analyze all markets including stocks, commodities, forex, and more.
Unfortunately, many beginner day traders are terrible at technical analysis. Some usually identify patterns on a chart that are incorrect or are not even there. As a trader, you need to develop a clear trading system and avoid basing your decisions on indicators or patterns that you don’t fully understand.
Start by learning simple support and resistance, or indicators that are easy to grasp like moving averages. Keep in mind that the fewer technical indicators you use, the better. Experiment to find one or two that work best for you and master them.
Day trading is often viewed as a challenging and risky activity, and it is. This type of market speculation is not only about making calculated trades or booking profits, but it’s also about managing risk and knowing when or when not to jump into a trade.
If you can avoid some of the mistakes we’ve highlighted in this post, there are chances that you can succeed in day trading and earn profits. The helping hand of a professional investment advisor too can help you to trade without emotional interference and become a disciplined trader.