Top Ten: Trader Behaviours That Cause Mistakes – Part One

In this week’s instalment I wanted to take a look at some of the typical trader behaviours that cause so many problems for new traders. Learning to understand why these behaviours exist, how to identify them and how to avoid them, is key to finding trading success. Read on for the first five…

1. Chasing Too Many Rabbits  

  • Many traders simply look at far too many charts. Instead of honing their skills by focusing on just a few chosen pairs and getting really familiar with how those pairs trade and behave and learning to understand the subtle nuances of each pair traders simply scan through as may charts as they can hoping to find some action. This generally leads to an outcome which is the opposite of what the trader expects. Instead of reaping larger gains traders generally take more losses. The reason for this is that instead of patiently waiting for prime setups to occur, traders simply try and jump into whatever seems to be moving often leading to spontaneous trading and the breaking of rules. Avoid this by focusing on a few pairs and learning to be patient and build your selective process.

2. Paralysis By Analysis

  • Many traders make their trading decisions unnecessarily complicated by trying to consider as much information as possible. For some traders this behaviour is indicator based whereby their charts are covered in different indicators giving various signals and readings. For other traders this behaviour involves trying to apply too many different methods of analysis such as harmonics, Elliot wave reading, trend lines and support & resistance etc. It is good to build filters into your trading system but really one is enough. Look to establish a clear setup and then identify a good filter for whether or not you execute this setups. Considering too much information is totally unnecessary and impairs your ability to make decisions efficiently.

3. Herd Mentality

  • Many traders seek comfort in the “safety of numbers”. When taking a trade, these traders will look to see how other traders are trading and trade accordingly. If other traders are bullish on a pair, they will buy, if they are bearish on a pair they will sell. This behaviour makes them feel more secure about the trades they are taking and also adds an element of deniability in the instance of losing trades: “oh well I lost that one, but everyone else thought it was going up to and they were all wrong also, at least It wasn’t just me”.  When you consider that 95% of retail traders are unsuccessful it is ridiculous to look to trade the same way as “everybody else” and generally, trading against the herd yields the best results.

4. Recency Bias

  • This particular behaviour poses common traps to many new traders and in-fact is often most prominent among aspiring systems traders who base their EA’s or algos on the recent behaviour of an instrument rather than considering a longer-term look at the instrument’s behaviour. Recency Bias often leads to “curve fitting” whereby systems are traded because they yielded impressive results over recent data and traders believe as these results are “recent” they are likely to continue; For the most part this is not the case. Avoid this by ensuring longer-term backtests when designing systems and if manually researching a strategy again make sure to consider a fuller data set rather than just recent data to ensure system isn’t curve-fitted.

5. Loss Aversion

  • Perhaps one of the most difficult aspects of successful trading is learning to embrace losing. Losing is part of the game in trading and although there are countless marketing pages plastered all over the internet telling you otherwise, there is no 100% system. To make money in trading we have to take risk and when we take risk there is a chance we will lose. The name of the game is to win more on winning trades than you lose on losing trades and maintain a strike rate that allows for profitability over time. If you win 3:1 on winning trades and have a strike rate of 40% then over 100 trades you will be up 60r (so long as you maintain uniform risk per trade). So although you will be profitable in the long run you will have encountered 60 losing trades out of 100. Many people equate “losing” with failure and so learning to understand the function of losing traders within long term trading is crucial to success. Many traders will sometime ignore their trading strategies and pass on trades because they fear losing. Ultimately it is precisely this behaviour of loss aversion which leads to failure.

Tune in next week for the second part of of this series and in the meantime, why not check out some of our other “Top Ten” articles here!

 

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