CFD trading can be a fantastic tool that shares wealth-building power with the general population. It does this by allowing you to trade and profit from financial markets with a very low barrier to entry. Within a few minutes, almost anyone can be opening long and short positions on the price movements of everything from shares to commodities and cryptocurrencies like Bitcoin.
However, this low barrier to entry also comes with risks for new traders. It means you can start CFD trading without knowing the full suite of tools and techniques for protecting yourself and your wealth, which leads to some beginners losing money very quickly.
Avoid these five common mistakes, and you’ll give yourself a much better chance of trading success in the long run.
Overtrading
The key driver of overtrading is the deeply human fear of missing out (FOMO). This happens to first-day beginners and 30-year veterans alike. For example, you may have a defined strategy for trading a certain commodity. But, you hear on the news that certain stocks are in an attractive bull run, so you emotionally decide to take out a long position in this area that’s outside your current strategy.
This is overtrading because you’re using your valuable resources (funds and time) in a trade you’re underprepared for. You’re more likely to lose in this trade since you’re diverting your resources away from your successful strategy. This can also include making more trades than you planned in a given asset class or trading pair.
To avoid overtrading, you need to be disciplined in the number of trades you make each hour/day/week, and in the markets you trade. Create a trading plan that limits your trading to within defined bounds and stick to it.
Overleveraging
Leverage in trading is a way to increase the value of your position without putting down more money. For example, with 10x leverage, you can open a position 10 times greater than you could without leverage. The benefit of leverage is that it increases your profit potential. But, it does this by also increasing your risk. Overleveraging is when this risk becomes too high and it becomes almost inevitable that you’ll lose everything.
What overleverage means is that your trades are too risky to be sustainable. If something goes wrong (which is common in all types of trading), you don’t have enough “buffer” to protect yourself from a complete wipeout. As a trader, you should focus more on the size of your positions than on the leverage ratio. Your risk should be small enough to allow you to make multiple (20, 30, or more) mistakes in a row and still not be wiped out.
As a general rule, beginners should stay away from leverage (especially high leverage) until they understand risk completely. After all, leverage is one of the key reasons CFDs are banned in the US.
Not Controlling Losses
Uncontrolled losses can devastate your CFD trading portfolio quicker than you can imagine. There are two main reasons for this. First is simply being unprepared and leaving falling positions unchecked. The second is a strong human psychological bias that leads us to stick with bad things too long, called the “sunk cost fallacy”.
To control the first, you simply need to use the trading tools available to you on any good trading platform. The main one is the stop-loss. These automatically close your position for you if your losses get too large. As a rule, you should put stop-losses on all of your trades, no matter how confident you are that the price will go up.
The sunk cost trap drives us to keep going with an endeavor past the point of rationality, simply because we have already poured so many resources into it. This is an error of judgment due to our emotional nature. You can use stop losses and defined trading rules to preemptively choose your exit points before you get emotional.
Not Locking Profits
The opposite of the sunk cost fallacy is staying with a trade longer than you should because you feel it’s already been so successful, it just has to continue! As a result, you resist locking in profits to see how much higher this can go (or lower in the event of a short trade). Improperly managed, this can lead to you losing a disproportionate amount of your profit over time.
To avoid this, use the opposite of a stop-loss, which is the take-profit trigger. This trading rule will automatically close your position for you to lock in your profit at a certain level. This allows you to make the take-profit decision before your trade is open and your emotions start running high. It also means you don’t have to constantly monitor the markets to make sure you get out at the right time.
Avoiding Reentries
Many people claim that learning when to re-enter a position is one of the hardest trading skills to master. But it’s actually quite simple. Close your position when it makes sense to do so. But then, re-evaluate the market to see if it makes sense to re-enter with a new position, just as you did when initially evaluating the merits of the position.
This doesn’t necessarily mean re-entering the position in the same way. E.g. if you just recently closed a short position, and your fundamental analysis suggests the market may have bottomed out, you can re-enter via a long position. As you’ve already done the groundwork in a trade you’ve just exited, you’re in a great position to re-evaluate and re-enter. Just avoid the psychological biases mentioned above!
Summing Up
Many of the most common mistakes made by traders involve not managing their emotions properly with the tools available to them. Avoid the drive to overtrade and overleverage, while using tools to make sure you take profits and control losses. If you follow these principles, you’ll greatly increase your chances of success with CFD trading.
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