Most investors believe that only other people make mistakes. However, the fact is that the vast majority of traders and investors frequently make mistakes. In order to help you figure out the best course of action when trading, or simply to refresh your memory, here is a list of some of the key mistakes to avoid.
CFD = Contract for Difference
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Too little preparation for CFD trading
Many people start CFD trading without a trading plan, thinking they will be able to beat the market. But trading is not that simple.
You need to set your trading rules and guidelines.
At a minimum, you need the most important components such as trading methods, a procedure for determining trading positions, entry and exit rules, risk management and trading logs.
Think of your trading as a business.
You need a business plan. Set goals, understand what you want to achieve and answer the following questions:
Why are you trading? To make money?
If that’s your answer, then perhaps you should think again. How do you want to make money?
How high do you imagine the rate of return? Remember, the more money you risk, the higher the potential return, but the potential losses are also higher.
What kind of losses can you take? What kind of losses would keep you up at night?
Which products do you want to trade? Stocks? Currencies (FX)? Commodities? Indices?
Obviously you cannot be an expert in all of these areas, so you should really consider which areas you are comfortable trading in.
In fact, you should only trade what you know.
Since there are so many products that can be traded, it is tempting to trade all sorts of products that you may not have had any experience with.
For example, if you are normally a share trader and want to trade CFDs, you should trade share CFDs.
What is the value of CFD contracts? How are they structured?
Did you know, for example, that 1 CFD on the DAX future at a price level of 11,000 points has a total volume of €275,000 (at €25 per point)?
Trade with the Right Stop Loss
If you are day trading, you will likely need tight stop losses in order to avoid excessive losses.
On the other hand, if you are trading more strategically, you will likely need more generous stop-losses and will trade smaller positions. Or maybe you don’t place a stop loss at all?
For example, if you buy Daimler shares with a value of €50,000 as a day trade, you should consider a 2% stop loss and not a 10% stop loss, which would be appropriate if you were trading in Daimler shares as part of a longer-term investment.
There are two forms of overtrading: frequency and open positions.
Today there is a wealth of information available to the investor, be it through a newspaper, trading magazine, website for investors, trading signal program/platform or directly from your broker.
All of these sources provide trading ideas for the investor to consider.
It’s important to remember that you have a choice as to which of the suggestions you will implement and also how many.
The more you trade, the higher the risk. And you can be sure that there will be more and more options in this regard.
A consequence of frequent trading is usually that you will likely end up holding too many positions in the hopes that they will all ultimately generate profit; this confuses you and affects your decision-making process.
This also often means that your positions become chaotic and are easy to lose track of.
You must consider how often you trade as part of your trading plan, and you need to check the frequency of your trading activity regularly and not stray too far from the trading restrictions you have set.
Excessive Leverage When Trading CFDs
One of the greatest advantages of CFDs can also lead to the most costly mistakes.
You have the option of trading large positions with a low level of security (margin), but that doesn’t mean that you actually have to make use of the maximum that your platform allows.
Profits and losses are related to the size (value) of your positions and not to the initial margin.
Always consider the maximum risk of all of your positions and the possible losses on those positions.
The risk warning “trading with leverage carries a high level of risk to your capital and it is possible to lose more than your initial investment” is cited for good reason.
In our opinion, excessive leverage is the biggest destroyer of CFD trading accounts.
Let’s take a look at the following example: You have €10,000 in your CFD account and buy 20 DAX contracts with a point value of €1.00 when the DAX is at a price level of 10,500. That’s a total of 210,000 euros in risk. If the CFD on the DAX30 Cash falls 4.5% (which can happen within a few days), you have lost € 9,450, or almost the entire value of your account. This is a classic case of excessive leverage, and it means that you have no leeway if prices fluctuate greatly.
Not Keeping a Trading Journal
When trading, it is important to keep a trading journal. When you open a trade, you need to document it:
- Why did you buy this stock?
- Where did you read about it?
- When did you make the decision to sell the stock?
Later on, it is very important that you analyze the trade, regardless of whether it is a profit or a loss. Was it a good stock pick? Did you stick to your plan? Is this a trade you want to repeat?
All of the answers will help you become a more disciplined trader and will improve your trading in the future.
Well-known stock market legends such as Warren Buffet are relentless when it comes to analyzing their trades and taking responsibility for mistakes.
Do you want to prove that you are right or do you want to make money? Nobody likes to be wrong. In fact, we always tend to think that we are right and that the market is wrong, but that can be a very expensive habit.
If the market moves contrary to our belief, we have to face the fact that our assumptions may have been wrong and learn from market developments. Though instead of doing this, many people sink more and more money into a losing trade in the belief that they are right and that the market is wrong.
At moments like this, it makes sent to recall two quotes from John Maynard Keynes:
“Markets can remain irrational longer than you can remain solvent.”
“When my information changes, I alter my conclusions. What do you do, sir?”
Repurchasing is Risky
We’ve all been there. It’s a great stock. We know everything about it. It has good fundamentals and a history of growth.
But now, for some inexplicable reason, it fell by 30%. We buy more because it’s even better business at this rate, and when it goes up we can make up for the initial loss. Then the stock falls another 20%.
The math related to getting back to break even can surprise many traders who haven’t really looked into it. If a stock falls by 20%, it has to rise by 25% in order to reach the breakeven point or the entry price.
If a stock falls 30%, it must rise 43% in order to reach the breakeven point.
If a stock falls 40%, it must rise 67%. And of course, if a stock falls 50%, it has to rise 100%. How likely is it that a stock that has just fallen 50% will double in value?
Limiting losses early on is essential. Never fall in love with a stock.
Only Holding Long Positions
If you only have long positions in your portfolio, your entire strategy is based on the premise that prices will only go up.
This exclusively long strategy carries a high level of risk; if prices fall, all of your positions will inevitably lead to losses.
You are missing out on an indispensable investment instrument that will allow you to profit from falling prices, hedge your portfolio and give you the opportunity to trade pairs.
This means that your portfolio should have both long and short positions, so that your investments are more balanced.
Investors should be aware that enormous, practically unlimited, risks can be associated with a short position, as the price of a stock could rise indefinitely.
Holding exclusively long positions works well in a market that is moving up, but often there can be significant and sudden price drops. In this case, your losses can increase rapidly.
Short positions in your portfolio, if used correctly, can reduce your risk.
Another defensive strategy is to trade pairs. For example, let’s say you think Daimler’s stock will rise and BMW’s will fall. You can take a long position (buy) in Daimler and a short position (sell) in BMW.
This can reduce some of the market risk as you trade the difference between the two rates.
Unrealistic Expectations When Trading CFDs
You will hear of people who double their money trading CFDs or see ads claiming that you only need to trade 15 minutes a day and no longer need to work.
Anyone can double their money, just visit a casino and choose red or black, but there is always risk.
Your trading plan should include the various levels of profit you are trying to achieve and what you are willing to risk. That should tell you if the trade is justifiable.
Many investors expect very high returns. But you have to be realistic about your profit expectations.
For example, it would be naive to expect to generate an income of €2,000 per month from capital of €10,000.
Taking Too Much Risk
CFDs present a great deal of risk and so you should make sure that you can manage this risk; your trading plan should ensure this.
You should only be risking the trading capital that you can afford to lose.
You should adhere to your trading rules and guidelines, taking into account risk, open positions, diversification and leverage.
Use all the instruments that the trading platform offers, for example stop losses, guaranteed stop losses and trailing stops.
Always go through your trading plan before placing a trade.
If you are risk averse or do not have enough financial resources that you can also afford to lose, then trading CFDs is really not for you and therefore you really shouldn’t consider trading these products.
If you have any questions about trading CFDs, please use the comment function at the bottom of this page.