stock trading common pitfalls

Stock Trading: 8 Common Pitfalls

Trading on the stock market is a source of fascination to people looking to grow their wealth, but it comes with numerous pitfalls. Here lists some of the most common mistakes made by new traders.

If you have money to invest, you may well have considered trading as a way of earning higher returns than those delivered by more conservative investment vehicles like savings accounts and bonds. But while all investments involve a certain amount of risk, many new traders lose money by making rudimentary and easily-avoidable mistakes. Here, lists 8 common trading pitfalls and explains how these can be avoided.

1. Not having an investment plan

Many people treat trading like a gamble rather than an investment, but just like any other business, trading requires a concrete business plan with clear goals and a workable strategy. Ask yourself how much you are willing to invest in your trading venture and what returns you hope to gain over the long term. Creating a detailed investment plan is the first step to successful trading.

2. Jumping right in

While you don’t necessarily need a degree in economics to trade successfully, you do need to possess a good understanding of business and a clear idea of the costs and risks associated with trading. Once you have studied the basics of trading, you should also take advantage of the free demos offered by many brokers. These “simulators” allow you to perform trades using fake money, and can provide hands-on experience to complement your trading study. If you do not get to where you feel confident in your knowledge of active stock trading, consider safer alternatives like passively-managed funds (ETFs).

3. Choosing the wrong broker

While some serious traders take to the trading floor themselves, most make use of brokerage services to manage their trades for them. Today, a number of brokers operate online, making it easier than ever to sign up for their services and begin trading. While all brokers charge brokerage fees and various other fees based on transactions, the differences in fees charged by the cheapest and the most expensive brokers are huge. The broker comparison tool accounts for all the major costs charged by brokers and clearly shows what you can expect to pay at each broker.

4. Following hype instead of facts

From tabloid-like quotes by stock market celebrities to web content aimed at luring customers to unscrupulous brokers, the trading world is largely built on hype. But hype is primarily a tool connived by large investment companies to con small-time investors out of house and home. Serious investors look at the facts behind each investment.

5. Taking on too much risk

How much can you afford to lose? This is a key question which many traders fail to ask themselves. While trading on margin can leverage your capital for higher returns, it also multiplies the effects of losses. When calculating potential losses ahead of each trade, make sure to account for the entire amount you may lose – including the portion leveraged by your broker. Never risk more money than you can afford to lose without seriously impacting your financial life.

6. Investing in short-term trends

While there are a handful of investors who have managed to get rich quick on short-term trends, they are the rare exception. Buy-and-hold strategies, in which you hang onto securities over long periods of time to benefit from long-term growth, are a safer choice and help you avoid having your profits eaten up by brokerage fees. Before investing in a company, ask yourself if the products offered by the business have long-term growth potential. Alternatively, you can invest through funds which follow entire market segments rather than specific companies. But here too, you should look at the long-term growth potential of the industry in question.

7. Holding on to losing positions

We all have a difficult time admitting that we were wrong, and this often prevents us from letting go of bad investments. But sitting around hoping that your poor investment choices will turn around is one of the surest ways to lose money fast. If a trading position is steadily losing money, let it go and cut your losses.

8. Becoming an addict

While addiction is not usually a word associated with business, the “gaming” nature of trading makes it potentially addictive. While trading can make an interesting hobby, sustainable profits require research and careful investment. You need to remain focused on the investment aspect and understand when it is time to quit. If you find it difficult to pull yourself away from active trading, try out passive trading (with ETFs, for example).

More on this topic:
Online trading comparison
How to buy stocks
What is a stock really worth?

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