The Most Common Mistakes Traders Make

Here’s a simple guide to losing money in the financial markets. These are the most common mistakes traders make. Most traders make all three, but making even one is a recipe for losing.


Poorly Defined Exit Conditions

Before you enter a trade, you must have already defined your exit conditions. Every trade has at least three exit conditions:
  1. A Stop-Loss exit – this is the price that tells you, “my thesis is wrong, I need to close this trade at a loss.” The stop-loss order doesn’t have to be in the market, but it has to be a precise number, and the professional trader must make the commitment to close the trade once that price is hit.
  2. A Profit Target – this is the price you expect to reach to make a profit on your trade. Lacking a clearly defined profit target, you don’t have a clear idea of when to close the trade at a profit and will often let those profits melt away.
  3. A Trailing Stop Trigger – Once price begins moving in your direction, you want to have a strategy that will protect you so that a small profit doesn’t turn into a loss. You should pick a price somewhere between your entry and your profit target that – once hit – triggers your trailing stop strategy. (You do have a trailing stop strategy, right?


No Thesis

Successful traders can clearly state their “reason why” for the trade. They know how much profit they expect to make if their thesis is correct, how they will know if their thesis is incorrect, how much money they will lose if their thesis is incorrect, and how long they will leave the trade open before they know one way or another if their thesis is correct. Losing traders merely hope.

The five characteristics of a valid trade thesis are as follows:

  1. It has clearly defined entry conditions. These can be any combination of prices, indicators and/or external conditions that you wish, but they must be clear and unambiguous. You must know exactly why you are entering the trade, or – lacking all the conditions being met – know exactly why you are choosing not to enter the trade.  For example, “I will enter this trade long on the first day after the price closes up after having fallen below its 20 day moving average.”
  2. It has a clearly defined profit target. If you don’t know how much money you expect to make, you have no way of knowing how much money you can afford to risk.  For example: “I expect the price to reach the top of the 50 day price channel as of the day the order was opened.”
  3. It has clearly defined risk. You know how much money you will lose if your thesis is wrong. For example: “I will close this trade if the price drops more than eight percent from my entry price.”
  4. It has a defined expectancy. You know how much money you will make on average every time you execute this strategy. You will know roughly how many times you will win and how many times you will lose for a given number of trades. You will know your average expected loss per losing trade and your average expected win per winning trade.
  5. It has a time limit. Sometimes a trade hits none of your exits. In those cases, you also have a time limit set for your trade so that you can close it and move your money to something more profitable. For example: “If none of my exits are hit within 14 calendar days of my entry, I will close the trade.”


Failure to Test

Many traders will define their exits and their strategies, but never actually test those strategies before putting real money at risk. Any trade strategy that is clearly defined can also be tested against historical data. In fact, without such testing, it is impossible to know the expectancy of your trade strategy.

Post Mortem on a Non-Winning Day

Two Mistakes

I’ve had a real good first month of the year, but I screw up sometimes too. Before I talk about my ES Trade Plan for tomorrow, I want to review my mistakes yesterday. I made two mistakes trading the ES yesterday.

  1. The first was getting short at the very end of the day and allowing my order tobe filled during settlement. The trend was actually against me at that point – even though it had stalled – and I should know better than to get an order opened during settlement. The good news is that my stop loss worked fairly well, and I lost just one tick more than my planned risk. But again – I should know better than to get into a trade at that time of day.
  2. My second mistake was when I saw the late evening push to 1800, I did NOT open an order. I had planned to try to get short at that point, but I simply didn’t do it. Then at 1:30 this morning, it spiked to 1800, then plummeted almost 25 points. That is exactly the kind of trade I look for, but I simply didn’t even enter an order.

Review of Today

Once again, all the action was overnight. I had no trades today, thanks to missing the entry last night at 1798.

We opened today back inside yesterday’s range, traded up to the low 80s and down to my previously identified support at 1767. We actually tested a little lower than that, but – for my purposes – 1767 was honored. I like it a lot when I get that sort of confirmation. 1767 will be a good launching point for a long trade tomorrow.

The range during regular trading hours was more in line with the average day for this month, but the 5D ATR now stands at almost 27 thanks to three big range days in the last 4. That will likely settle down back into the mid teens soon, and my expectations for any individual day will continue to be for a range in the mid- to high-teens. If that proves wrong, I will have to adjust my expectations. (That’s actually a positive. I need to average 16 points a day, and that would be easier with an average range in the mid 20s.)

We are stuck between the 50Day SMA and the 100Day SMA at the moment.  I expect the 100 to provide pretty good support for the next few days, even though I will make a Short plan just in case.

VIX is below 16 still. It was affected by these three big range days I am sure. I don’t really trade much on the VIX, but I do pay attention to it. It’s mildly useful to me to have a normalized measure of market volatility.

ES Trade Plan for Thursday Jan 30 2014

Long (assuming confirmation) at 1767 with a target of 1788. However, I will likely take half the contract off at 1777. Since the trade will be worth a total of 20 points, I will risk 1/3rd of that, or just under 7 points.

Long (assuming confirmation) at 1788.50 with a target of 1800. Risk will be 4 points.

Short (assuming confirmation) at 1767 with a target of the mid 1740s. Like the long trade, I will take half off after 10 points and will risk just under 7 points. The fly in this particular soup is that the 100 is below us at 1757.50 and I expect that to provide support. If we can get through that and stay through it, then the mid 40s have a good chance.

Short (assuming confirmation) at 1788.50 with a target of 1767. I will take half off after 10 points and will risk 7 points.

I’ll give each of these trades about 24 hours to work.