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Top 10 Penny Stock Trading Mistakes
In penny stock trading, the fewer mistakes a trader makes, the more money he can make. As a trader, our number one goal is to reduce the number of mistakes we make.
To play the trading game, we should avoid the following 10 mistakes at all costs.
#1 Trading without an Edge
One of the biggest mistakes that beginners make is to trade without an edge. People buy a stock based on a tip from their friend, neighbor, or someone they meet at the bus stop.
This is absolutely the wrong approach to the stock market. Before you jump into penny stock trading, you have to know that it is a risky business and not a way to get rich quick.
If you want to make money trading penny stocks, you have to put in the time to learn and understand how traders make and lose money.
In stock trading, when you take a position, someone else would have to take the opposite position. Therefore, when you make money, someone else must have lost it. If you don't want to lose money trading stocks, you must gain an edge against the other guy.
So what's the edge? You need to collect data and study the charts of winning stocks. You want to find a pattern that works a good percentage of the time and take advantage of it.
#2 Trading without a Pattern
I personally spend about 2-3 hours each day finding stocks to watch, review my winning and losing stocks. I saved thousands of stock charts on my computer and I go over them from time to time trying to find stock patterns that perform well.
Some patterns work better than others. However, none of the patterns work 100%. During the times when patterns fail, discipline kicks in and helps me cut losses quickly.
Consistent is the key here. You may hit a home run once or twice, but if you don't have the money management skills, you will eventually give back all your gains.
Our goal is to focus on finding a winning chart pattern that performs consistently. A pattern has to have happened pretty often with a good winning rate to be considered a good pattern.
I keep all sorts of stock charts and group them in different folders, including the stocks that I made money with, lost money, and the stocks that I missed. I take notes about the chart and if I notice a pattern that occurs often, I will create a new folder that keeps track of all the stocks with that pattern.
#3 Trading Without a Stop Loss
Many people tend to fall in love with their patterns. If you have a pattern that works well in the past, and it fails on your current stock. Simply cut your losses and move on to the next trade. As I stated above, no pattern will work all the time.
However, I see people hanging on to their losing trade for far too long. They allow a stop loss to turn into a massive loss because they can't convince themselves to take a loss.
Some traders may even remove their stop loss completely which is the worst mistake that a trader can ever make. A penny stock trade without a stop loss is like a boat without a pilot, it will sink. You may get lucky a few times, but there will be one trade that ultimately crushed your account.
The reason they trade without a stop loss is that often when they cut losses, the stock would rebound right after they sold. Yes, it hurts when that happens, but that's the cost of doing business. You have to have these small losses in order to have big wins.
Remember, most penny stocks go to $0 in the long run, you are actually trading against the odds when you go long on penny stocks.
However, with proper management skills, discipline, and a sound strategy, you can make money going long on penny stocks. Having a stop loss on every trade is one of those rules that you absolutely must follow at all times.
#4 Trading without a Plan
Trading without a plan is like sailing without a compass, you will get lost. Beginners may think a winning trade occurs when he or she executes a trade.
That is not true, executing a trade is the easy part of trading. The difficult part is planning and knowing exactly how you are going to trade for the day.
For instance, I compile a list of penny stocks to watch every night based on my trading patterns. I also have an optimal entry price for each stock which is usually lower than the current price.
I would get up one hour before the market opens the next day and observe the pre-market actions. If I see any of my stock drops or reaches my optimal price, I will pay closer attention to these stocks when the market opens at 9:30 am.
Please note, I don't trade penny stocks during pre-market or after hours because stocks are volatile and the trading volume is low.
Once the market opens, I will study the daily and intraday charts of the stocks I like. If I like what I see and the price is right, I would trade the stock. If none of the stocks meet my criteria, I will not trade for the day.
I use Fidelity to trade penny stocks, and I import my watchlist in the Fidelity Active Trader Pro desktop software. This is the software that I watch my stocks and execute my trades.
#5 Trading with the Money They Can't Afford to Lose
Let's face it, trading is risky. No matter how good a pattern looks like and how sound your trading strategy is, there is still a chance that you will lose all your money.
In fact, most people lose money because they simply don't know what they are doing. Trading with the money that you can't afford to lose will make you focus only on the money instead of becoming a better trader.
When you spend time improving your trading strategies, you will get better, and that leads to profit.
However, you will not be able to make good trades if you are trading with the money that you borrow, because your decisions will be based solely on the money, instead of the pattern. You will get emotional and it will ultimately destroy your account.
When your pattern gives you the signal to stay on a trade, your emotion convinces you to sell. When your pattern tells you it's time to sell, your emotion asks you to hold on.
#6 Fear of Missing Out
Fear of missing out is a common mistake that traders make all the time. The fear of missing out mentality causes traders to jump on trade too early or chase a stock that has run away. In both of these cases, traders lose money.
Here's how fear of missing out causes the trader to jump early on a trade
- A trader buys a stock before his pattern is formed. He anticipated his winning pattern instead of waiting for the pattern to occur.
- The stock then drops and hit his stop loss
- The trader convinces himself to stay on the trade because his pattern needs a little more time.
- The stock kept dropping, and the trader has no plan to sell it.
- Only after the stock drops so much and the trader can't take it anymore, he then admits the fault and throws in the towel on the trade.
If you get on trade early a few more times, your account is ruined. Only buy a stock when your system or pattern tells you to do so. If a stock doesn't meet your buying criteria yet, the only thing you can do is wait.
Do not compound the mistake of jumping on trade early and not cut your losses quickly.
Chasing a stock is another scenario the fear of missing out mentality causes traders to act irrationally.
- When a trader sees a stock that he likes, but is still above his optimal entry price. He puts in a limit order to buy the stock, only to watch the stock skyrocketed without hitting his limit order.
- The trader gets frustrated and enters a market order to buy the stock at any price or limit order that was way above his initial entry price.
- Since his entry price is now higher than his original entry price, he must adjust his stop loss to a higher price.
- The stock then pulls back and hits his stop-loss order.
- The trader sells the stock for a big loss and blames his bad luck.
Instead of chasing the stock, a smart trader would simply skip the trade. Do not chase a stock that has run away. There are thousands of other stocks out there, some with better setups, waiting for the next one.
When a trader enters a trade that is far away from his optimal entry price, he will be shaken out by his stop-loss frequently.
#7 Double Down on Losing Positions
Doubling down on losing positions is a dangerous move.
When your stock drops, the wise action is to cut your losses and move on. However, many traders do the exact opposite, they double down on their positions hoping to recoup the losses.
There are a couple of reasons why traders do it.
First, some traders have a big ego problem which makes it difficult for them to take a loss. By doubling down, their losses appear smaller in terms of percentage. If the stock ever rebounds, they want to get out of their losing position by breaking even.
This is dangerous because if the stock keeps going down, you are now facing a bigger loss instead of a small one. A trader may double up on their winning positions, but should never double down on losing positions.
Some traders love a stock or a pattern so much that they double down when the trade goes against them. If the original entry price is attractive, after the stock went down, the price will appear even more attractive. That seems to be a good reason to own more shares of losing stock. However, as a trader doubles down, he is taking more risks. When the stock declines further, it will destroy his portfolio and his confidence in trading.
With that being said, never fall in love with a pattern or stock. If a trade didn't work out, the market is giving you a signal to move on.
Overtrading is a mistake both beginners and experienced traders make. I still make this mistake from time to time, especially after a few big wins.
When trades and money are going your way, sometimes you may feel overconfident. That's when you start to make mistakes and have a tendency to overtrade.
Here are a few signs of overtrading
- Jump on trade early anticipating a winning pattern rather than waiting for the perfect setup.
- Trading with bigger positions that you can handle emotionally.
- Trading with random chart patterns that don't have enough data and statistics to back it up as a winning pattern.
- Trading too many stocks that you simply don't have time to make good decisions on each stock.
Some traders overtrade after big losses because they want to make back the money that they just lost.
This is very dangerous because the market doesn't know or care that you just lost money, and the market doesn't owe you anything.
If you are on a losing streak, you should be taking a break instead of trading.
#9 Not Tracking Your Trades
Tracking your trades is critical in trading success especially when you are just getting started.
Tracking allows you to see the mistakes that you make and flaws in your trading methods or system.
The goal of tracking is to constantly improve your trading strategy, so you get better results.
In stock trading, mistakes are unavoidable. However, we can reduce or eliminate our errors by tracking our trades. Through tracking, we can spot exactly how each mistake is made and what we can do to correct it.
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#10 Not Obsessed with the Market
This is probably one of the critical mistakes most beginner traders neglected. If you are not obsessed with the market, you shouldn't be trading in the first place.
Successful traders make good money, so do doctors, lawyers, and many other high paying professions. If it takes years of school and practice to become a doctor or a lawyer, why should trading be any different?
Many new traders come to the market expecting to make big money but are not willing to study and learn how the market works. These traders will fail.
You may have seen successful traders trade stocks, and it seems pretty easy for them to make money. With a few mouse clicks each day, they are able to make a living sitting comfortably in front of the computer while in pajamas.
However, you have not seen the full picture behind the scenes. They may have spent hundreds of hours learning about the market and still spending hours each day looking for trade setups, planning trades, tracking statistics, and improving their trading skills.
Needless to say, if you want to make money in the stock market, be obsessed with the market.
For stock market beginners, I recommend you start with paper trading. Allow the first few weeks or months to study stock charts and collect data.
Paper trading is useful for beginners to hone their craft without risking hard-earned money. At the same time, he or she can find and test chart patterns that may work.
However, keep in mind, paper trading is different from live trading. When traders paper trade, they make logical decisions and fewer mistakes. As soon as their money is on the line, they start making decisions based on emotion.
It takes time and effort to learn how to control your emotion. Some traders take a few months while others may take a few years. It all depends on how much time you are spending to track your trades and fix your mistakes.
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