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Trading Too Often and Trading Too Little – How these affect your portfolio
Education | 30 October 2009

This month’s article is about the frequency of your trading. In my experience of teaching forex and stocks trading to new traders, I noticed a common pattern among those who lose money. Frequently, they either trade too often or they trade too little because they are afraid to deal with any losing trades.

Trading Too Often
Excessive trading is one of the most common factors to losing money in the market. In any 12 month calendar market, there will be 4 – 6 months of clean market moves. This means breakouts that are directional and fairly predictable, thus, you would be able to be profitable very quickly.

New traders tend to find comfort in the profit zone. I remembered reading a survey that found new traders were willing to hold positions twice as long when they were 5% profitable versus 5% negative. In reality, a 5% fluctuation from your purchase point is inadequate to decide on the progress of the trade.

In the recent March 2009 rally, if you started trading stocks from that month onwards, you would have made 80% by simply riding on the Straits Times Index. That is a wonderful level of return! In fact, if you targeted to grow your portfolio by 25% a year, you now have 36 months of advance profits. You can wait patiently for the next good market entry, even if it takes 3 years!

Thus, the logical position right now is cash, or only quality blue chip stocks that you plan to hold for years to come. Nevertheless, many new traders would be emboldened by their recent success and go out searching for more profits every day. This is simply ignoring the fact that markets will always rotate into volatility before reverting back to a lower volatility state.

This is where they will start eroding their profits, and net returns reduce dramatically.

Trading Too Little
On the other hand, we have the other group of new traders who tend to trade very little and they will only trade when all the elements are aligned. This is great for long-term investing; meaning a time frame of 3 years or more.
Nonetheless, for shorter term trade positions, you will miss out on profitable trades that you need.

In the previous situation, over-confidence and greed are the dominant emotions, while in this situation, fear is the dominant emotion. The fear of losing money deters new traders from entering trades. The fear that a trade will result in them losing money. The natural pattern then is to wait for the trend to be too obvious to be wrong, before they enter. However, this is also the point where markets start to reverse!

In the same march 2009 example, fearful traders would wait till the market trend is extremely established before taking a position. Thus, they would only get a small amount of the move that is left. Assuming they managed to get one quarter of the March 2009 rally, they would have achieved a 20% return. It definitely sounds good at first glance, however, your next few trades may require you to lose some of your profits.

A trader who made 80% can lose the next 5 trades at 5% per trade and still be up a decent 45%. Those 5 trades also give him the opportunity to profit from future moves. The trader, who made only 20% returns, would not be able to invest in 5 more trades because that would turn the portfolio negative.

Manage Your Emotions
Legendary billionaire, Warren Buffett frequently advises people to learn to manage their emotions before managing their money. A trader’s emotion dictates the outcome of their trading portfolio.

That is why you should always work on how you can have the most profitable response that is least affected by fear or greed. Once you can manage your emotional state with any instrument, you would be able to transfer that clarity to your other trading instruments.

You want to be bold when the markets move powerfully, and conservative when it stalls sideways.

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The Shares Investment editorial team welcomes constructive feedback on our coverage and content. We would also be delighted to answer any questions on the above article. Leave us a comment below, and we'll get back to you shortly!

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