Why You Must Factor in Trading Mistakes

If you day trade, just by the sheer number of trades that you’re likely to take over time, it’s incredibly likely that you will make trading mistakes.

People new to trading are particularly prone to mistakes. They might not be fully competent with their software or not understand the potential consequences of trading outside of their trade plan for example. Believe it or not although mistakes are far less common for more experienced traders, they are by no means immune from making them from time to time either.

I’m not sure that many people would claim that trading mistakes are uncommon or non-existent. However, when setting out trading goals, many people fail to account for the potential cost of mistakes.

Types of trading mistakes

Personally, I classify trading mistakes into two different categories. This is because they are caused by different things and generally traders react to them in different ways.

The first type of trading mistake is really a trading error. A trading error in my book is somewhat of a glitch in the system –not something caused by a choice as such but a lack of skill in using your trading platform. An error can be something like selecting the wrong price, executing the wrong size or buying instead of selling.

A fountain pan on top of a financial reportThe key part to trading errors is that whatever they are, they are done unintentionally. They can also be collectively referred to as “fat finger” errors.

Trading or fat finger errors are generally more common in newbie traders but you shouldn’t dismiss them out of hand just because you’ve been trading for a while. Tracking and actively working to improve your error rate is part of honing your skills in this craft.

The second type of trading mistake is a trading violation. A trading violation is a mistake where you intentionally choose to trade in a way that is outside of the rules of your trade plan (of course there are many traders who choose to trade without much of a plan if they have one at all and this could be seen as a mistake in itself!). A violation could be trading outside of your normal hours, doubling up on a position or trading over an economic release for example.

Violations aren’t going to be the same for everyone of course. Trading over releases might be a core part of your trade plan. The key to this is whether you are going against whatever is in your trade plan (again, if you have one – and you really should!).

Problem #1 – Unrealistic expectations

If you don’t account for the possibility of trading mistakes, the problem becomes rooted in your business plan. You may feel like you have a good understanding of the markets and enough of a decent enough strategy to be successful based on a run of simulated performance.

But even if your simulator is close to being an accurate depiction of live performance, in my experience people are quick to remove losing trades from their results when they were because of errors and even quicker to forget that they’ve done it! In this type of scenario, it’s easy to see that a trader funding their account with $5,000 is in danger of being severely under-capitalized (a common scenario).

Then there’s the situation where people do what they’re told to by reading and listening to those who’ve been in the game for a while and do their back-testing on a strategy (which is something you should do). They come up with the results and whilst they recognize that markets fluctuate and strategy performance will vary, they do not account for user error!

Problem #2 – Perfection seeking

You may be able to get angry with yourself and still do the right thing, but for many of us, getting angry is the beginning of things starting to unravel. One violation can always lead to another and over time, cost a huge amount in account equity.

The trouble is, if you don’t know what your common mistakes are likely to be and moreover, be expecting them to happen, you’ll in effect be expecting perfection.

This is a problem for two reasons.

The first is that you will be far less accepting of mistakes when they do happen. This is dangerous. If you are thinking logically and understand that mistakes do happen, there shouldn’t be a problem. But if your Chimp is controlling you and you are acting based on emotions, you’ll not take it lightly.

When this is the way you’re reacting, the result of not achieving perfection is likely to be fear or aggression. Fear by getting out early or setting tiny stops (and achieving account death by a thousand stop-outs) for example or aggression by allowing your Chimp to go on a revenge trading rampage – which is only likely to lead to more, costly violations.

Emotionally driven errors in my experience, also tend to be addressed less effectively. Someone who accepts nothing less than perfection each time is highly likely to believe they will achieve it. With this kind of misconception it isn’t uncommon for a trader to not track the cost of their mistakes at all or work to address them – at least to begin with anyway.

If you know what your mistakes are, track their impact and have techniques for dealing with them, they’re far less likely to result in catastrophe when they do occur.

Acceptance and forgiveness

Planning for the possibility for trading mistakes can help you to be realistic in the assessing the potential performance of a strategy and identify an appropriate amount of account capital you might need. Being able to let go of trading mistakes when they do happen but still working to reduce their frequency can save you a huge amount in account equity and emotional capital.

Finding the balance of acceptance of trading mistakes and trying to minimize them isn’t always the easiest thing, but if you fail to address this at all, it will be more than likely cost you dearly.

Trade well.

For more updates from Mark and the team at NetPicks, be sure to visit their trading tips blog at NetPicks.com.