Published April 19, 2012
Day trading sounds so easy, doesn't it? After all, isn't it just sitting at your computer all day, buying and selling stocks -- and piling up profits? Well, not exactly. Few people realize how much experience and skill is needed to make money as a day trader. It's easy to get tripped up by mistakes, especially during your first year.
Here are 10 of the most common errors many day traders make.
"The most common mistake traders make is entering a trade without a good plan," says Toni Turner, author of "A Beginner's Guide to Day Trading Online."
"Nearly every mistake can usually be traced to trading without a plan." Too many rookie day traders enter the market without appreciating that they are wading into potentially dangerous waters. Protective planning against losses means determining your entry price for buying a particular stock, your exit price and an escape price -- also known as a stop loss.
If there is anything that can destroy a day trader's account, it's margin. That's when you borrow from a broker to buy securities. If used properly, margin is a valuable tool that can boost profits and give traders breathing room. When margin is used improperly, financing a trade with borrowed money can be dangerous to your wealth. In the past, many people misused margin, borrowing more from the brokerage than they could afford. It wiped out some traders' accounts and helped to give day trading a bad name. It's best to day trade with money you actually have, not money you borrowed.
One of the most common day-trading errors is chasing a fast-moving stock on the way up or down. More than likely, this could lead to an unprofitable trade. "When we see a stock go higher and higher, we all want to join in the celebration," Turner says. "The problem is that experienced traders are going out the back door while new traders are coming in." If you miss a stock on the way up or down, let it go. There will be other trading opportunities.
Not everyone agrees on which is best -- market orders or limit orders. A market order is an order to buy or sell a stock at the current market price. With a limit order, you can establish your maximum or minimum price for trading a security. Market orders get filled fast, but you let the market control your order. Conversely, limit orders allow you to control the parameters.
"Now that spreads are a penny or two on many stocks, limit orders make no sense," says Deron Wagner, founder and head trader of Morpheus Trading Group. "You could miss a fast-moving stock just to save a few cents." With high-quality liquid stocks, you can use either a market or limit order.
At least once, nearly every trader gets fooled into buying stocks based on tips from persuasive sources. Even when the tipsters are right, they aren't there to tell you when to sell. It takes a lot of self-control to keep your ears closed, but successful day traders rely on their own judgment -- not on what others are saying.
It's human nature to hope that a losing stock turns around. But if you're a day trader, refusing to cut losses can damage your account. "Instead of hoping for a stock to go back up, take that money and transfer it into a stock that is really going up," says day trader John Kurisko, host of Day Trading Radio. When a stock is headed south, be disciplined enough to prevent a small loss from turning into a much bigger one.
The first and last 15 to 20 minutes of the trading day are usually chaotic, as market orders are filled from anxious investors rushing to make moves near the opening or closing bell. You also are competing with institutional and high-frequency traders. "The first and last 15 minutes are too volatile for new traders," Kurisko says. "It's like the Wild West, and sometimes there is no rhyme or reason to it. Also, the indicators don't have enough data, so they get choppy."
What does it take to become a better trader? Discipline. "You need to develop a set of strict rules that takes the emotion out of a trade," Kurisko says. "Most day traders use technical analysis."
For example, Kurisko uses stochastics, an indicator used by many traders to determine if a stock is overbought or oversold. If the stock is oversold, then he starts to buy. "You must listen to the charts, not the news," he adds.
Some rookie day traders keep looking for something magical that will bring them easy profits. A few have already calculated how much money they plan to make in the market. Unfortunately, the market has other ideas. "Don't seek a silver bullet," Wagner says, "because there isn't one. Some people will jump around looking for different instruments and strategies without taking an honest assessment of themselves. There is no easy way to play the market." He says traders need a strategy, rules and discipline to become profitable.
Uninformed day traders think that anyone can make money day trading. But to be successful at it, you'll need training. "If you were laying on the operating table, waiting for your surgeon to take out your appendix, you wouldn't want that surgeon to walk in reading a pamphlet, 'How to Remove an Appendix in 10 Easy Lessons,'" Turner says. She says to be a consistently winning trader, you should start with paper trades, and then study hard so you understand how the market works. "Learning to day trade successfully can take as long as going through college and obtaining a degree," she says.