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Chapter 4
Know Your Enemies
While becoming a successful day trader isn’t possible without making mistakes
and learning from them. There are plenty of serious pitfalls that you can be
aware of in such a way that it makes you less likely to have to experience them
yourself. Keep the following in mind and remember, forewarned is forearmed.
Chasing bottoms and tops:
There are certainly some strategies out there that are
effective when used near the turning points of existing trends. These are in the
minority, however, which means that picking bottoms and top is, more often
than not, a risky proposition. Unfortunately, it is an all too common mistake for
traders to invest money into securities that are either too low or too high,
gleefully ignoring the 2 percent rule as they do so. This impulse should be
avoided like the plague and replaced with a focus on major inbound price moves
instead. Sticking to one side of markets that are range-bound will lead to better
long-term results at least 90 percent of the time.
Not having a good exit plan:
It is common for new day traders to have a plan
when it comes to getting in on a potentially profitable trade without having an
equally solid idea for when they are going to get back out. This then leads them
into scenarios where they get out too early and miss out on some easy money or
stay in too long and either end up with an investment or end up being forced to
take a loss despite the promising start. If you are having a hard time coming up
with the right exit points, the easiest place to start is by focusing on adding
detailed technical specifications to your exit strategy. After you have put these
into play, it is important to not stick with them blindly and to instead change
them up as need be based on the changing market environment.
Trying to get even:
While most new day traders start out with a plan of some
type, they often make the mistake of letting their emotions take over and when
that happens it is very easy for a plan to go out the window. It is important to
keep in mind your trading goals as well as your long-term plan when this occurs
as trying to get even with a specific stock, either by doubling down or by holding
onto it well past the point where logic would dictate that it is time to get out, will
only lead you to a loss far more than it will work out in your favor.
This is why it is so important to focus on the numbers to the exclusion of all else
which means removing your ego or self-esteem from the picture entirely.
Focusing on the price action to the exclusion of all else will make it easier to
block out aberrant thoughts relating to magic numbers or breaking even, which
will naturally improve your overall trade results, possibly to a significant degree.
Keep in mind that determining whether a day is a success or a failure isn’t
something that can be done until the final trade for a given day has been
completed.
Sticking with relative trends:
If a trend is already well-defined in the market then
it is entirely possible that it is going to continue long enough for you to make
some money off of it but it is far from a guarantee. The market will naturally
fluctuate up to 20 percent of its current average with very little warning, before
settling back to the current standard. This means that if you recklessly jump onto
a specific trend without doing the required homework you will frequently find
yourself making a momentum play that is never going to go anywhere.
Before you make a move regarding a specific trend, there are three distinct
timeframes you are going to want to consider first. If you are prone to trading in
the short-term then you are going to want to keep an eye on the weekly hourly
and daily charts. If you prefer holding onto trades for a longer period of time
then daily, weekly and monthly charts are typically going to be more useful.
Being too focused:
Many new traders get so focused on a specific trade that they
forget that no trade exists in a vacuum. Not keeping this in mind is a surefire
way to hurt your overall successful trade percentage with losses that are, by and
large, avoidable. The more profitable solution is to instead keep a strong macro
view of any trades you are considering working with. Keeping tabs on the
market in this way and looking for potentially profitable trades is a great way to
track general derivatives. These derivatives are crucial when it comes to
managing the underlying conditions that occur between markets while also make
sure they are currently moving in the same ways. With that being said, it is
important not take so much of a macro view that you lose sight of what is most
important. A balanced mix of macro and micro is always going to yield to the
best results.
Letting the opinions of other influence your trading:
While every day trader is
going to have opinions regarding the best way to trade this type of stock or when
to use that indicator, the best day traders tend to avoid this advice like the plague
and instead work out their own. The only thing you really need to focus on in
order to make the right types of trades in the right timeframes is math and
anything else is only going to get in the way. Keep in mind that you want to
analyze and observe economic and political events, not get caught up in them.
Timing it wrong:
As hard as it might be to believe, finding a trade that is likely
to be profitable in your desired timeframe is only half of the battle, you also need
to learn when the right time to pull the trigger in order to determine the right
results. Making the right move at the wrong time can easily cost you a big profit.
How big exactly? Making the right move costs day traders around the world
upwards of 10 million dollars per day. This doesn’t mean that you need to wait
to make a trade until the stars align and everything is perfect, just that you will
want to focus on getting a feel for the best moment to start a trade and then act
on it directly.
To do this you are going to need to keep in mind the relatively trend you are
following and understand the strength of the market as a whole. While doing this
you are going to need to keep an eye on the distribution and accumulation
indicators as well. Most importantly, however, you are never going to want to
move on a tip or a hunch without taking the time to do the required research
beforehand. Anything else is akin to throwing the commissions you paid into a
pile and burning them.
Averaging down:
While few traders, even those who are new to day trading, start
off the day with a plan of averaging down, it is something that they often end up
doing because they didn’t take the time to actively plan against it happening. The
truth of the matter is that the resources spend holding onto a weak position will
almost always cost you more than if you had ended a trade and used those funds
elsewhere instead.
Remember, every time you end up with a failed trade that means the next trade
needs to be even more profitable overall in order to make the entire day work out
to a profit instead of a loss. If you get into the habit of averaging down, and your
trading capital wasn’t terribly strong to begin with, then a few days of doing so
can easily equate to days or even weeks that will be required in order to just get
back to where you were when you started. If you prefer to trade in the short-tern
then you will need to be ready to exit a trade the instant that forward momentum
begins to slow down, or even worse, starts to move in the other direction instead.
Not factoring in risk and reward before you make a trade:
Risk and reward are
an important part of every trade. This in no way means they are going to be
equal, however, and if you don’t take these differences into account then you can
easily make the wrong moves without even realizing it in the moment. If a given
trade has enough risk to cost you 2 percent of your overall trade capital then you
are going to want to ensure that it pays out at least twice that much (3 times as
much is better) to make it worth your while. Likewise, a signal trade that is
worth 10 percent of your total trade capital is always going to be riskier than 5
smaller trades worth 2 percent each. Keep your risk reward ratio in mind for
every trade or you will wish you had when you find your trade capital
dramatically depleted.
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