People are fascinated with the idea of trading stocks for a living. Yet, like most performance-based businesses, most people are not able to succeed. There are many reasons why people can’t beat the market – or achieve their desired outcomes. Here are three common and easily avoidable mistakes people make on Wall Street.
No Plan:
One of the most common mistakes I see people make is that they do not have a plan. They start trading and hope it works out well. Or they start trading only looking at how much money they are going to make and they do not calculate the potential risk. Or they just wing it and hope it works out well.
An easy way to illustrate the power of having a proper trading plan is to think of two different (unrelated) people who want to go on a vacation. One person is yelling and screaming that they want to go on vacation and the other person picked the destination, bought plane tickets, booked a room, and rented a car for the duration of their trip. Who do you think will get what they want? The person with the plan or the person with out a plan? Clearly the person with a plan has a much higher likelihood of accomplishing their goals than the person without a plan. This is true in just about all aspects of life. The solution is to take some time and create a plan. Study the market and ask what criteria works for you and what doesn’t. What do you want to see before you buy a stock? What do you want to see in order to sell it? How much do you want to risk if you are wrong and the stock goes against you? These are just some of the questions people ask in order to create a proper trading plan. The key is to find something that works for you so you can create your plan before the market opens then step back and trade your plan.
Emotional Trading:
Another common problem is that most people end up making emotional, not rational, decisions with their money. They don’t know how to get out of their own way. Over the decades, I’ve learned that the best traders in the world make rational, not emotional, decisions and they do this by having a plan and then trading their plan. Another benefit is that this process helps people avoid “over trading” or revenge trading. Meaning, people just lose track of reality and end up making way too many trades that hurt their performance. If you plan ahead and then step back and follow your plan you will know (before the market opens) where you will enter, where you will exit, and how much you will risk if you are wrong.
Don’t Respect Risk:
My experience has taught me that perhaps the most important mistake people make is that they do not respect risk. Risk management is arguably the single most important tool successful traders and investors can use to get ahead. Why? Because every trade has an inherent level of risk involved and the best market participants tend to be the best risk managers.
One of my guests (big money manager) told me on my SmartMoneyCircle.com podcast (I interview large money managers and CEO’s of publicly traded companies for timeless advice) that he does not buy and sell stocks, instead he buys and sells risk. He went on to say that we all buy and sell risk. I thought that was brilliant! The solution here is to plan your risk before you enter. This way you know how where you are going to enter, where you are going to exit, and how much you are going to risk of your portfolio if you are wrong.
Bottom Line:
I can write an entire book about the mistakes people make trading capital markets. I have made more mistakes over the last 25 years than I can remember. The good news is that we can learn from our mistakes. That said, these are just three common mistakes people make and how you can avoid them. I encourage you to objectively look at your mistakes and ask yourself, what can I learn from this trade?
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