Every day, new traders enter the marketing, thinking that all it'll take is a few good trades before they're living the Wolf of Wall Street lifestyle. They're excited, they're ambitious, and -- nine times out of ten -- they're going to crash and burn before they get any traction as traders.
What gives? How can Wall Street be thriving when it seems virtually impossible for individual traders to get a foothold in the market? The answer lies in the misconceptions that too many amateur traders have about what trading is and what it entails.
So whether you're thinking about getting started as a stock trader or you've already executed your first trade, watch out for the following mistakes. If you aren't careful, they'll tank your profits before you even come close to making the leap from amateur to professional.
Amateur Traders Follow Hot Stock Tips
I really hate to break it to you, but if you get your stock tips from the ads in Barron's or the mailers that show up in your mailbox, you don't have a "hot stock tip" -- you're being played.
Think about it... if somebody really had a hot stock tip, why would they print it publicly like that? Why wouldn't they keep it to themselves to take advantage of?
The secret is that the people who publish these ads are trying to take advantage of you. Often, they're part of what's known as a "pump and dump." A company or stock promoter wants to get a stock moving, so they send out an ad -- knowing that all the suckers out there are going to jump on the bandwagon as soon as they see it.
But, behind the scenes, they've already "bought low." All they need is for you to drive up the price by buying based on their ad so that they can "sell high." They profit, you lose.
So if you can't trust stock tips, how should you decide which stocks to buy? All you have to do is learn the patterns.
The thing about stock trading is that individual stocks go through repeatable, predictable patterns -- again and again. If you learn how to read them, you'll know when to buy, sell, short sell or buy to cover. You'll never have to worry about relying on other people's tips ever again.
Amateur Traders Force Trades
I've got to tell you -- I'm not that smart, and I'm not that great at math. But what I have learned, over more than 15 years of trading experience, is that stock trading is as much a mental and emotional game as it is a mathematical one.
Here's one of the biggest mistakes I see new traders making...
They have a successful trade or two, but then they hit a string of losses. This isn't unexpected -- no trader wins on every play.
But amateur traders haven't figured out how to handle these losses yet, and they start to get anxious. They're desperate to succeed, so they jump on opportunities that aren't really all that good in the hopes of scoring some quick profits and making themselves feel better.
That's what I mean by "forcing a trade." You convince yourself that a setup is better than it really is, all because you're desperate for the sale. You push it -- and you wind up losing when the play falls through.
Don't trade when you're emotional about your losses, and don't trade when the numbers aren't there. It's a tough lesson that all traders have to learn for themselves, but it's one that separates amateurs from professionals.
Amateur Traders Put Too Much Faith in the Market
I make a living trading penny stocks and teaching others how to do the same. And another mistake I see these new traders make all too often is getting caught up in the hype surrounding penny stock companies.
The reason I point out that I trade in penny stocks is to make it clear that I'm not dealing with companies like Apple or IBM. I'm dealing with bottom of the barrel companies that don't even come close to meeting the regulatory requirements to be traded on top exchanges like the NYSE or AMEX.
But do you remember that buzz I mentioned above, with penny stock companies and stock promoters hyping up their stock to try to get you to buy in? One of the ways they do that is to tell you that a penny stock is going to be "the next Microsoft," or "the next Apple."
You get excited about getting in on the ground floor, so you buy. Eventually, the promoters and other insiders sell off, leaving you squeezed when the pump and dump falls apart.
I don't like to sound cynical, but you have to be at least somewhat jaded when it comes to trading these stocks. Buying into a stock based on your hopes and dreams of riding a penny stock from $1 a share to $100 simply isn't realistic, and it's going to cause you losses if you aren't careful.
The numbers don't lie, but promoters do. Make your plays based on what the market is telling you -- not what you hope will happen.
Amateur Traders Don't Minimize Their Risk
A lot of people get really wide-eyed when I tell them that I trade penny stocks for a living. "Tim," they tell me, "I could never do something so risky!"
But here's what you need to know... Anything is risky if you don't know what you're doing. Heck, even walking down a busy street is risky if you don't know how to wait for the crosswalk light to let you pass safely!
There are tons of different steps you can take to protect yourself from risk as a penny stock trader, including:
1. Setting your risk-reward ratios. I don't enter a play unless I know when I want to get in and when I want to get out. I don't just "let it ride" -- I set entry and exit points based on how much risk I'm willing to take on in exchange for a certain potential reward.
2. Getting out early. Having defined risk-reward ratios means that, sometimes, I get into or out of a stock earlier than I should. It's frustrating to see my students earn bigger profits by staying in trades longer, but I'm a conservative trader. I'd rather take a small profit than risk everything -- even if getting out early means missing potential profits.
3. Watching your position size relative to your portfolio. If you gamble 75 percent of your portfolio on a single trade, you deserve to get wiped out because you weren't careful. Success in trading is all about doing whatever it takes to stay in the game. If you don't keep your position sizes small relative to your portfolio, you risk trading away your ability to play in the future.
These are just a few of the lessons I've learned throughout my trading career -- and they're lessons I've learned through hard work and mistakes. You'll make plenty of your own mistakes throughout your trading career, but if you're careful about watching out for the four listed above and about learning from the challenges you face, there's no reason you can't be one of the few that succeeds.
Have another mistake you'd like to add to this list? Leave me a comment below with your thoughts on why traders fail.