Things to Avoid: Overtrading and Oversized Positions

In speculation and in financial spread trading it is best not to overtrade. Overtrading has been the bane of my trading career to date.  I have mastered timing, I have mastered money management but I still find myself failing when it comes to overtrading.

So why do we overtrade? I cannot answer for anyone else, but I know why I do it.

Trading is like no other business I know. You can’t bring the market to you, it cannot be forced; and you cannot impose your will. You can push for sales, you can increase productivity or improve quality control of your product. But when it comes to Mr Market, a can do attitude can be lethal.

Sure you can read books, test systems, chat to other traders. But when all said and done trading is a task completed with minimal effort;  requiring only the click of a mouse button and the management of trading positions once a day. In a sense it is the easiest business in the world. And that is why we all have the budding trader inside of us.

But there are problems with such effortless ease. We humans like to create, we like to achieve. We like to force our will onto things. Speaking for myself I like to be busy, even on the toilet I need to be reading a book otherwise its one humungus waste of my day (I know, I need to chill a little). I think many are drawn to day trading for the simple reason they feel they are doing something. At least day traders have a sense of a full working day, even though by and large they are the biggest losing group of traders.

Anyway having to do something, either through boredom or through wanting to push your trading business forward has always been counterproductive for me. On balance I always lost money.  The losses always dented my equity curve and my trading psyche suffered as a result.

Trading less and with a suitable edge would have saved me a small fortune and a few grey hairs to boot.

I am not alone. They say some of the biggest and constant losers in the trading game are often the most successful in the business world. Go getters, movers and shakers, people who went out and carved their success onto the world. But in the trading world profts can rarely be maintained that way. And that is why alot of traders go to the wall. As Jesse Livermore used to say “the big money is made in the sitting and waiting”.

I do not overtrade for the buzz, I overtrade to make things come quicker. More fool am I. It is wrong and I know it. Overtrading has been my hardest lesson to learn and I am still learning it.

In essence spread betting is like every other form of gambling, there are do’s and don’ts. Here are some pitfalls to avoid….

  1. Over confidence. Did you know that your ego and winning can make you broke in trading? The more you win, the better you feel and your ego starts taking over. Get over confident in spread betting and you may lose the ability to think rationally. This may cause you to bet more than you should and do yourself some financial harm. For instance in my first year I had a fairly strong run of winning spread bets and as my profits mounted I started seeing myself as a skillful and talented spread better. However, readers of Nassim Nicholas Taleb’s excellent book Fooled By Randomness would immediately spot a problem: my success may have been entirely down to pure luck! I got my comeuppance on the dot-come bubble in March 2000 when several of the technology stocks I was invested in crashed by more than 10% in a few days of trading and I ended losing more than 10,000. So don’t rely too much on leverage and watch your liquidity as a wrong-sized bet could easily wipe you out. And don’t expect to become a millionaire trading the stock market just because that newspaper advert said so! So understand what you’re trying to achieve and set achievable targets!
  2. A common error is oversized positions. It’s best not to commit more than 3-5% on a single idea depending on your confidence and the perceived sweetness of the trade. I mean 3-5% of an idea not each company. One error among people who think they have diversified is to risk say 5% of capital on each of Xstrata, BHP Billiton, Rio Tinto, Anglo American, Lonmin, Vedanta and all the rest. If the forces driving up this lot fail they all go down together. A lot of people have bet most of their money on oils/metals shares failing to see the correlated positions and have come unstuck in a big way. It’s not too much different to taking an oversized position in just one of your favourites. Remember, you’re in this game for the long haul, so don’t feel you have to make big bets to make it worthwhile. Better to keep things small and successful, than overextend yourself. Small points over time lead to big prizes.
  3. Overtrading is another mistake. Traders need to undertand that that ‘standing aside’ and neither being long or short at a particular time is also a position, when waiting for a potential trigger point to trade/invest. Standing aside and having the patience to either go long or short at the right time is one of the best ways to try and make maximum money. Not just blindly having to be long or short at all times, that is just plain silly. Unfortunately, spread betting at times tends to get out the gambler in people! People tend to hold shares more long-term and so lose less – they also trade less. Spreadbetting thus encourages people to over trade which they wouldn’t do with a normal account. It gets to a point where people just have to trade every day on something or other. Some newbie traders just trade too frequently and/or deal in too many markets without realising that most day traders are nothing more than market feeders, supplying the easy money for seasoned sharks. Remember also that the ‘spread’ that spread betting firms charge you each time you enter a deal can have a dramatic effect ?n profitability over time especially ?f you tend to do a lot of small term trades. For most people if you trying to trade more than about 1-2 times a week you might need to ask yourself why. It’s best to trade only when you see a ‘sure thing’ with a relatively small chance of being wrong, so do cut back on the number of trades you do by cherry picking the higher probability ones. These kinds of trades don’t come along every day.
  4. Emotional betting. In a nutshell these are hope, greed and fear. Bet with logic, not your heart. Resist the urge to have bets on teams or markets you like, instead bet on what the prices and stats say. Also, do not enter trades based purely on fantastic news!! Basically, again you get emotional, spot an opportunity to make some ‘easy’ money and jump in without any plan. No idea of where to exit to take profits or where to place your stop. The key here is to learn about yourself and then consistently and consciously strive to develop the traits that allow you to trade well.
  5. Interfering with your trades. This again relates to emotional betting. Once you set up a trade you absolutely shouldn’t interfere with it. You set it up such that the entry and exit are completely automatic. You’ll walk away with say either a £200 loss or a £600 gain (if risk:reward is 1:3). Nothing else is allowed. The problem is that if your strategy wins only, say, 40% of the time (which is fine with a risk:reward of 1:3), this implies that there is a greater possibility that you will lose any one trade (60%) and you get all worked up and not thinking about things as rationally as perhaps you should). Do this and you’ll end up losing; if you are down considerably on a trade, doubt has a way of kicking in and then you get prone to second guessing trades or hesitating too much and waiting too long and entering trades too late resulting in even more losses. Repeated losses doesn’t means that your system is bad. You could make that back in your next 4 trades (but then again you might not!).
  6. Betting against the trend. Many novice traders will look at some charts, decide this is as low as it can go, and place a trade going long. This is a common mistake, the chart can always go lower and you are placing a bet against the trend. Always have a reson other than acting on impulse. Intuition is just a hunch; it has no bearing on trading the world markets. Ok, it might work once or twice, but in the end it could cost you far more.
  7. Impatience. The market has far more patience than most traders. Great bets do not come up every day or week. Sometimes you will have to bide your time and wait for an opportunity to present itself. Better to have one great spread bet than 5 bad ones. I’ve seen many people say things like ‘I’ve just bought £10k in BARC’s, it may go lower, but I just couldn’t wait any longer’. Things like that is just not the way to do it. If Barclays share price fell another 10%, then you are 10% away from making a profit compared to what you would have been if you had waited. There is a short saying in trading which states that the market will do whatever is necessary to drive the largest amount of stock market traders bonkers. Trends can persist for as long as there are sufficient stock market traders fighting them. Don’t be a victim.
  8. Over-leverage – The first thing any trader learns along the painful journey of trading is not to get too highly leveraged in the first place. £100 a point is just a ridiculous amount of leverage if you only have £10,000 or so in your bank. It’s this ‘greed for cash’ that is more akin to gambling than trading and how many gamblers win long term…not many. The thing is if you have £10,000 in your bank and you buy the FTSE 100 at £100 a point, and by some chance you guess correctly and it goes up 50 points you sell having made £5,000. The next day you do the same at 200 a point and so on…it only takes one black day when you guess the market wrong and you’re wiped out. Not only that but betting too big a stake means that you are more likely to get panicked out of the market by a small move…if you want to limit your potential maximum loss to no more than £100 on a trade then it is silly to use a tight stop of just 10 points while staking £10 a point. Some time ago I was at a ‘free seminar’ sponsored by CMC, and their guy told an amusing anecdote about some muppet who’d blown up in a big way, and he added parenthetically that they were still pursuing him through the courts to reclaim the full extent of the losses he incurred (i.e. above and beyond his deposit/margin with them).

Too much of something is not good at all Be it salt, sugar, pepper or spread betting! Same goes to everything. Everything in life is gamble, you need to predict it will not rain when you step out of your house, not getting rotten food from a particular hawker stall, you aren’t in good health even when you are trying your best to stay healthy…So I suppose, self-restraint is the main key 😉

I was on a business trip earlier in the year and I was sat on the plane close to a guy that worked for one of the large spread betting firms who was off to start a branch of their business there. He was explaining how they operated to the guy sitting next to him and I found it quite fascinating from the perspective of someone who uses spread bets.

Basically he was saying that the business was incredibly simple. You had the vast majority of punters who lost money and a very small minority of punters who made money. As someone was identified as being a ‘winner’ they elevated them to a special list and fully hedged their positions. The interesting thing he was saying though was that the reason the others tended to lose over time wasn’t that they consistently chose bad stocks, it was merely a psychology thing. People tend to run loses then close them out after they reached large levels. People tended to either cut gains quickly for small profits or tended to gear into gains – so that when the price trend changed they quickly gave back all their profits.

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