How to Avoid the 10 Costliest Trading Mistakes: Transcript

Paris Hotel Las Vegas

Delivered at the 2011 Las Vegas Traders Expo by Tim Racette

If you’re looking for the video recording click here.

Hi everyone and welcome to today’s re-recording of my presentation given at the 2011 Traders Expo, in Las Vegas. My name is Tim Racette and it is my pleasure to be speaking with you.

In today’s presentation you will learn about the 10 costliest mistakes a trader can make and I promise you will take away some valuable techniques for avoiding them.

90% of all those who try their hand at trading fail within the first 3 months. Of those who make it past the first 3 months, 90% fail in the next 3 months, and by the end of 1 year, fewer than 10% remain.

The goal of this talk is to give you a specific action plan to avoid 10 costly trading mistakes. I’ll provide steps to ensure you don’t fall victim to these mistakes in hopes that you may one day join the top ranks of elite traders.

Over the past 6 years I have made a number of my own trading mistakes. I’ve documented these mistakes and compared notes with other top traders, seeking out best practices. I have condensed this knowledge into today’s presentation titled How to Avoid 10 of the Costliest Trading Mistakes.

About me

A little bit about me. I am a full-time options and futures trader. Born and raised in the Chicago-land area. I’m also an Arizona State Sun Devil. It was in Arizona that I discovered one of my other passions, mountain biking. I really enjoy travelling and had the good fortune to spend some time in Costa Rica last spring. If you’ve never been, I would highly recommend it. You can read more about me, my trading, and my travels at my blog, EminiMind.com.

My presentation today is comprised of 10 slides; each covers 1 of the 10 costliest mistakes I feel you can make as a trader.

Having missed more than 9,000 shots in his career, lost almost 300 games, and on 26 occasions was entrusted to take the game winning shot and missed, Michael Jordan says, “I have failed over and over and over again in my life. And that is why I succeed.”

What does the path to success look like? It starts with learning. How do you yourself learn best? Are you an auditory learner? Do you learn by watching? Or do you learn by doing? For most of us, the path to success comes in the form of making mistakes.

In trading, mistakes equal losses, painful draw downs to your account, the feelings of defeat and failure. Inherently it is not until we feel this emotional pain that we learn our lessons. At this point in trading, it can often be too late.

I ask you over the course of today’s presentation to step back and take an honest look at your trading to determine which mistakes you identify with. In doing so, you will be better equipped to move to the next step, avoiding them.

Impulse Trades

Reactionary response

The first mistake common to most traders is impulse trading. Maybe you’ve heard the saying “Luck favors the prepared.” If you’ve ever found yourself entering a trade impulsively you know that these trades usually result in a loss.

The main error here is that you are unclear of the exact setup which you are looking for. Take the time to plan out and develop criteria for entering and exiting your trades as this will equip you with patience when it comes time to pull the trigger.

Triggered on emotion

Human emotions are incredibly powerful. We are all striving to behave like traders. Our attitude are what influences our behavior and our emotions have a strong influence upon our attitude, therefore we must learn, not to eliminate our emotions, but rather, not to act on them.

Know your setups

Part of my nightly homework routine is to go through the day’s price action and review all the setups for the day. This is a great way to build confidence and trust in your edge. I review all the trade setups I took and consider it a successful day if I’ve followed all my rules.

Grade your trades

One exercise I can suggest for avoiding impulse trades is to grade your trades. For trades where you followed your rules perfectly regardless of the P/L outcome, give the trade an A. If you broke any rule at all, give it a C, and if you entered on impulse, give it an F. At the end of the day or week go back and see which trades were net profitable. You’ll find that over time it is the A’s, the trades where you followed your rules perfectly, that produce the net profits, while the C’s and F’s result in losses.

Break your rules and you will fail

The only guarantee in the market is that if you break your rules, you will fail. Challenge yourself to be disciplined 100% of the time, all the time.

Not Using Loss Limits

The second costly mistake is not using loss limits.

Define your risk per trade

Traders who do not use loss limits are one bad trade away from catastrophic failure. I define my risk per trade well in advance, risking no more than 1% of my total trading capital per any one trade.

Set daily and weekly limits

You can set hard daily and weekly loss limits with your broker to prevent a devastating account blowup. I recommend limiting yourself to a maximum 5% drawdown on the day and a weekly loss limit should be no more than 10%. If you are regularly seeing these loss limits get hit it is time to go back to the drawing board and find out where the issues are.

A trading journal like StockTickr is a great way to fine tune your trading edge and is the journal that I use for recording and analyzing all of my own trades.

Eliminate the big loser

There are really only 4 possible outcomes to any trade; A BIG winner, a small winner, a small loser, and a BIG loser. By eliminating the big loser you have dramatically increased your odds for profitability. You can do this by defining your risk before you place the trade and risk no more than 1% of your trading capital.

2 Stop Out Limit

After going back through my trading days I found that I never had a winning day when I took more than 2 full stop outs. For this reason I limit myself to 2 full stop outs on the day. This protects me from continuing to trade when the market is clearly not producing an environment conducive to my trade setups.

Live to trade another day

The one time you decide to break these rules will be the time that devastating draw down occurs. We put these measures in place so we can live to trade another day. It is when we are at our weakest that we need these loss limits the most.

Trading Too Big

Trading too big is the third costly mistake.

Understand risk capital

Obviously no one likes to lose money, but your trading account should be funded with money that if lost, won’t affect your current lifestyle or extend your retirement. If you have net worth is $50,000 then it will be pretty difficult to put $25,000 of that money at risk in your trading and be comfortable trading it.

Don’t trade with $ you can’t afford to lose

I’d like to read a short excerpt from author Jack Schwager in his book Market Wizards. Mr. Schwager says “If your trading capital is too important, you will be doomed to a number of fatal errors. You will miss out on some of the best trading opportunities because these are often the most risky. You will jump out of perfectly good positions prematurely on the first sign of adverse price movement only to then see the market go in the anticipated direction. You will be too quick to take the first bit of profit because of concern that the market will take it away from you. Ironically, over concern about losing may even lead to staying with losing trades as fear triggers indecisiveness, much like a deer frozen in the glare of a car’s headlights. In short, trading with “scared money” will lead to a host of negative emotions that will cloud decision making and virtually guarantee failure.”

Think risk first, then reward

Measure the risks first and if you can accept them move forward with the trade. Once you’ve defined your risk the profits will then make themselves available.

Earn your way to trade larger

There is no faster way to fail as a trader than increasing your contract size just because you think a trade is going to be a home run. In doing so, one loss can eat away at weeks, if not months of profits and sometimes end a traders career. Define your risk and always use stops.

Don’t rely on trading to pay bills

The psychological stress that is generated from relying on your trading to pay the bills, at least at first, can cause you to force trades and fail as a trader. Integrate trading into your current lifestyle and slowly make the transition to trading full-time (if that is your goal). I recommend having a year’s worth of living expenses in the bank to be able to make the leap to full-time trading so that you are not relying entirely on your trading account. This helps you focus and keeps your mind objective and thinking clearly.

Influenced by Others

Mistake number 4, don’t become influenced by others.

No one can predict the market

There is no one that can predict the market, Period.

Keep opinions to yourself

I find it’s best to keep your ideas and opinions to yourself in regards to trading. Engaging in discussion about your opinions of the markets can lead you to change your thesis and may prevent you from putting on that winning position.

YOU are in control

You are in complete control of your success or failure as a trader. You must hold yourself accountable for all trading decisions.

Hold your opinions loosely

If you have formulated an opinion about market direction, hold it loosely. Make sure to have a plan B, a backup plan. What will I do if the market doesn’t act as anticipated?

Anything can happen

Trade in the now with the information in front of you. Remember that anything can happen.

Lack of Planning

Treat trading as a business not a hobby

You’ve probably heard this saying before, “treat trading as a business not a hobby.” It’s an important one. Hobbies cost money; businesses make money so take your trading seriously. Lack of planning is the 5th costly mistake on our list.

Preparation and routine are key

The markets are wild. A routine creates structure around this spontaneity. When a lawyer gets assigned a new case, the first thing they will often do is prepare the arguments for the opposing side. This helps identify any gaps and questions that could arise. I find that it’s always best to over-prepare.

Discipline 100% of the time, all the time

Each time you let your guard down, make a mistake, or break your rules money is lost. There really is no room for mistakes in this game. You must force yourself to be disciplined at all times.

Write it down

Writing out your trade setups and goals will help bring clarity to your ideas. I do this process repeatedly which is one reason for starting the EminiMind blog. I find writing forces me to think through my ideas in depth and dig down to the core idea.

There are no short cuts

As Malcolm Gladwell talks about in the book Outliers, it takes 10,000 hours to fully master a cognitively complex subject. Put in the time both during and after market hours, studying, reviewing charts and more importantly learning about yourself to better understand human behavior.

Too Many Indicators

Analysis paralysis

I’m sure we’ve all suffered from this one, having too many indicators forcing you into a state of analysis paralysis. I challenge you to go through and simplify your trading screen. Remove any indicator or chart that does not directly relate to your trading plan. This will help remove the noise and conflicting signals when it comes time to pull the trigger.

Less is more

There are a million and one ways to skin a cat, and there are many ways to trade successfully. Sometimes, the less information you have on your screen the better you will trade.

Define your core setups

As we just discussed with writing down your setups and goals, define those core setups that work well and give you that edge. Focus on executing them perfectly the exact same way each and every time. This is the foundation of your trading and will be extremely important for your growth as a trader.

Revenge Trading

Next we come to revenge trading.

Wait for the next best opportunity

After taking a loss as yourself where is the next best opportunity? Often times newer traders feel the need to make back that loss immediately on the same instrument which took it from them. You must force yourself to remain patient and wait for the next valid setup.

Each trade is individual to itself

Don’t let the outcome of a prior trade influence the next trade. This is very difficult for a new trader who, after taking a loss, wants to “make it back” and get revenge. Because your last 3 trades were losers you decide not to take the 4th which it turns out was the winner that made up for the 3 losses. Reviewing your trade setups and knowing exactly what you’re looking for will help overcome this.

Create a statistical edge

Using a trade journal such as StockTickr is a great way to compile your data and establish your exact edge in the markets. The discretionary trader must focus on managing each trade the same way or the statistical edge will be skewed.

Think in terms of ticks not $

One trick that helped me early on was to think in terms of ticks and not dollars. This helped keep it more of a game rather than strictly making and losing money.

7x7x7 breathing

Throughout the day, especially after taking a stop out try the 7 x 7 x 7 breathing technique. Breathe in to the count of 7, hold your breath for the count of 7, and then breathe out slowly to the count of 7. Doing this helps calm the body and bring you back to a state of clear objectivity. Let’s try it together. Breathe in to the count of 7. Hold for a count of 7. Breathe out slowly to the count of 7.

Taking Profit too Early

Number 8, taking a profit too early.

Scared of losing

This was a big one for me. We take profits early because we are scared of giving back what we’ve already made. Knowing your edge and probabilities will help to remove this fear. In reviewing your trades each night, go back and look at where your max profit was and see if you can find any commonalities which may lead to an ideal profit taking point or trailing stop method.

Let the system work

Don’t rush it. Force yourself to remain disciplined and use patience. Place your effort into trailing your stop as opposed to dragging in your profit target in.

Review setups each night

Review your setups each and every night. As said before, this was a crucial step to build confidence in my trading.

Focus on trading well

The profits will follow if you can simply eliminate those big losers, stick to your plan, and strive to detach yourself from the emotions of winning and losing money.

Over Trading

Over trading is the next costly mistake many traders make.

Define your core setups

Over trading is a in a big way led by impulse trading. In defining your setups you will know exactly what you are looking for and won’t feel like every signal that you see is a trading opportunity.

Patience pays

Sometimes there are no setups, and that’s okay. It’s better to be +0 on the day than down.

Filter your trades

Look to find commonalities among the winning trades. Sometimes this is easier to do by looking for similarities among the losing trades and filtering out groups of those trades. This is an iterative process and you will continue to evolve as a trade adapting to changing market conditions.

Loss limits stop the bleeding

As we talked about earlier I limit myself to 2 full stop outs on the day. Never have I had a winning day where I kept trading after I took 2 full stop outs. This is the markets way of telling me it is not conducive to your trade setups for that day. Stop the bleeding and come back the following day.

Hesitating & Chasing

And last but certainly not least, we come to the mistake of hesitating and chasing trades.

Use limit orders

I only use limit orders and I recommend you do the same. A market order is almost as catastrophic as an impulse trade.

Trade entry check list

Once you’ve defined your setup, execute. Write down your entry criteria on a note card and keep it in front of you so you will know exactly when the setup is valid. This way you won’t feel the need to chase or jump in late feeling as though you’ve missed the move.

Gain screen time

And finally make the commitment, put in the time both during and after market hours to gain that screen time looking at charts and mastering your setups.

Let’s review the 10 Mistakes we talked about today and give you an action plan to leave here with.

Action Plan:

1. Do your own thinking
2. Write out your entire trading plan
3. Set loss limits (per trade, daily, weekly)
4. Keep your position size small
5. Simplify your trading screen
6. Execute each trade according to plan
7. Limit yourself to 2 full stop outs per day
8. Take walks and breathe deeply
9. Review your trade setups each  night
10. Commit.

Put in the screen time, those 10,000 hours. Make the assertion to yourself that, if being a trader is what you so strongly desire, you will do whatever it takes to succeed.

Thank you for your time. I wish you the best of luck in your trading!