Why is it that some traders make good money from trading whilst others tend to trade around break even and just tread water even though they both have similar levels of expertise and are apparently doing very similar things. Well once you have learned the basics of trading the difference between achieving either of these two outcomes can be down to just very small differences in behavior and actions. ie you can be doing almost everything right but still not pick up the big money.
Here are three errors that even often competent and experienced home based traders still make that hold them back from achieving the big rewards that are available in trading.
Holding on to losing trades and cutting profits short on winning trades is a classic mistake. When you look at results from trading systems often you will find that almost all of the total profit earned could be attributed to just a few of the biggest winning trades. If you take profits on all your trades too early you will never have these critically important occasional homeruns that occur on what is known as the long tail of the statistical distribution. Our natural tendency to grab at any profit may well prove right and comfortable in the very short term but in the long term over a series of say a hundred or more trades it will prove to be counter-productive. One of the world’s greatest traders is quoted as saying “trading is counter intuitive” what feels right and comfortable is often the wrong course of action over the long term and what feels wrong and uncomfortable is often what in the long term makes sure rich.
Going for very small profits – so-called scalping – is also a classic rookie mistake. Whilst the professionals can and do scalp the markets they have many advantages over most normal home based retail traders. One of the many problems for retail traders is the spread – the difference between the buying price and the selling price. Whenever a retail trader puts a trade on he’s immediately down by the spread. For example let us assume that you are paying a 2 pip spread. If you then go for a 5 pip profit even if you win on the trade 40% of your profit is eaten up by the spread. Conversely if you go for a 50 pip profit only 4% of your profit is taken by the spread. Don’t fall into the trap of trying to scalp the markets as a retail trader – it does not work.
Going for poor risk reward ratios also rarely works over the long term. I would recommend a minimum risk reward ratio of 1:1. This means that if your stop loss is 20 pips away the minimum profit you should be looking for is also 20 pips. In my own trading I typically look to average a risk reward ratio of 1:1.5 plus over a series of trades.
If you go for a risk reward ratio of less than 1:1 you put a lot of pressure on the strategies win rate to ensure that you come out ahead. For instance if I use a 30 pip stop loss and 10 pip profit target (a risk reward ratio of 3:1) I will need to have at least 75% winners just to break even. Over a long series of trades this is very very difficult to achieve. Conversely if I have a risk reward ratio of 1 to 3 (risk 30 pips to make 90 pips) even if I only have 33% winners I will still break even.