DIY trading and investing has exploded in popularity thanks to easy access to local and global stocks markets via online platforms like Clarity, with its low trading fees, intuitive interface, and a wealth of available market information.
While this has empowered a new generation of retail investors and traders, those that rush in to get their share of the markets can often make costly mistakes that can quickly erode capital.
It is important that traders and investors fully understand the rules and risks of trading to avoid common mistakes, especially when using leverage through margin trading or Contracts for Difference (CFD).
Trading Without a Plan
A fundamental mistake many DIY traders and investors make is entering the market without a clear investment plan or trading strategy.
Taking a haphazard approach by buying and selling stocks or taking positions based on tips, news hype, or emotions rather than logic and structure is not a recipe for success.
It is important to create a trading plan that defines your goals as this will dictate your strategy – are you investing for long-term growth, passive income, or short-term speculation?
Your trading or investing plan should also define your risk tolerance, risk management rules like stop-loss levels, entry and exit criteria, and position sizing.
Review and refine your approach over time based on the results, but avoid changing your approach based on short-term market noise or emotions.
Trading on Emotions
There is an important psychology to trading that traders and investors must understand before committing any capital to the markets that can often be volatile.
Mastering the emotional component of the trading process should focus on identifying and controlling the emotions that influence decisions, like fear and greed. These emotions often fuel irrational decisions.
For instance, greed often drives decisions that might increase risk as traders remain invested for too long before taking profits off the table.
Fear also has a powerful influence on investment outcomes, creating doubt that brings into question a trader’s market read or stock pick, which could mean exiting a position before the trade can play out, or can lead to panic selling.
As such, the ability to manage your emotions and maintain discipline is crucial to achieving consistent profits or managing losses when you choose to trade your way.
Be aware of biases like “loss aversion” – feeling the pain of losses more intensely than the joy of equivalent gains – and FOMO (Fear Of Missing Out).
A good way to understand your emotions is to document your trades, including notes about your rationale and emotional states. This can help identify patterns in your emotional responses and bad habits. Ultimately, every decision should align with your trading strategy plan.
Overtrading
Retail traders, especially those starting out, can get caught up in a wave of exuberance and excitement and trade too frequently. This overtrading can rack up fees and losses.
While the allure of quick gains or hot trading tips on social media can prompt additional trading activity, it is important to avoid the urge to chase every market movement. Focus on high-probability setups and only trade when the criteria set out in your strategy are met.
Insufficient Research
Blindly following tips, news headlines, or social media trends without doing your own due diligence is a recipe for disaster. Many investors put money into assets they don’t truly understand.
It is important to thoroughly research companies before investing to understand their business model, financial health, and competitive landscape. Take the time to learn about important indicators, chart patterns and technical data, such as financial ratios.
Neglecting Risk Management
Not having a clear understanding of how much you’re willing to lose on a trade, or risking too much of your capital on a single position, can wipe out your account quickly. This is why risk management is so important when it comes to trading.
Always define your risk before entering a trade.
Misusing Leverage and Margin
Many retail traders, particularly those new to the game, can come up short (pun intended) when trading on margin and using CFDs. While these instruments offer larger potential gains, they can also amplify losses.
When traders misunderstand and misuse leverage, it can lead to margin calls and rapid account blowouts if the market moves against your leveraged position.
That is why it’s critical to understand how leverage works and the risks and potential losses that come with leveraged trading.
New investors and traders should avoid highly leveraged products and start trading with your own capital before considering borrowing.
Before you invest with leverage, build up some capital as a buffer to cover potential margin calls, even if you don’t immediately need them for trading. Use margin and CFDs sparingly and only with a clear risk management plan.
Avoid using more than 2:1 leverage, unless you are very experienced, and never risk more than a small percentage of your capital on a single trade.
Poor Diversification
Concentrating all your capital in a single asset, a few stocks or a single sector can expose you to significant risk if those specific investments perform poorly.
Aim to build a DIY portfolio that includes a mix of stocks, bonds, and other assets depending on your risk tolerance and goals. You can also diversify within stocks by investing in different sectors, companies, and geographies.
Investing in exchange-traded funds (ETFs) is also a good way to gain exposure to instant diversification across a basket of stocks with a single investment.
Conversely, overdiversification is also a risk. Trading on too many markets is a frequent mistake among novice traders, often stemming from a desire to explore various markets.
However, spreading focus across multiple markets can lead to distraction and hinder the development of expertise in any one market. Inexperienced traders should resist the urge to jump around between markets and instead focus on mastering one market at a time, gaining valuable experience and improving their chances of success.
Trying to Time the Market
Predicting market highs and lows consistently is incredibly difficult, even for seasoned professionals.
Many retail traders fall into the trap of trying to buy at the absolute bottom and sell at the absolute top, often leading to missed opportunities or emotional decisions.
Investors looking to build wealth often perform best with a “buy and hold” strategy that makes regular contributions to benefit from dollar-cost averaging to smooth out your average purchase price over time.
Chasing Trends Hype
Jumping on investment trends or “meme stocks” without understanding the underlying business or valuation often results in losses rather than outsized gains.
Instead of following the herd, always do your own research and focus on investing in companies with solid fundamentals when investing for the long term. While the trend can be your friend, it takes experience to know when to exit trades when they get too crowded.
Novice traders may also lack the confidence to take a contrarian view when required.
Always study price action and volume, relying on quantitative data to inform decisions rather than relying on social media buzz alone to pick stocks.
While experienced traders understand that the trend can be your friend, they have the experience to exit trades when they get too crowded. However, new traders may stay in a trade long after the smart money has moved out of it.
Averaging Up or Down
Major losses typically happen when a trader keeps adding to a losing position and is eventually forced to cut the entire position when the size of the loss becomes unsustainable.
Traders also go short more often than conservative investors and tend toward averaging up, because the security is gaining rather than losing. This is an equally risky move that is another common mistake made by a novice trader.
Patience, Discipline, and Education
While the world of DIY investing and trading offers immense potential, it’s not a get-rich-quick scheme. Success hinges on a combination of thorough preparation, emotional discipline, and continuous learning.
By acknowledging these common mistakes and actively implementing strategies to avoid them, DIY traders and investors can improve their chances of long-term success in the dynamic stock market.
Ultimately, success when trading markets isn’t about being right all the time. It’s about managing your risk when you’re wrong and capitalising when you’re right.
