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Learn From Your Mistakes

Neophytes think their trading flaws will vanish after they get a few years of experience under their belts. But nothing could be further from the truth. In reality, even market professionals make costly mistakes that could have been avoided. On Wednesday I made 17 trades and cashed in a series of big winners. It was a good day, but it would have been better if I didn't throw money away with stupid trading mistakes. But I rarely lose sleep about these errors, because it's hard to play the game with perfect discipline, day after day.

The market forgives traders' mistakes in easy times, letting us profit despite bad judgment and poor timing. But it's a different story when no clear trend guides the price action. In choppy and confused markets, a big loss can follow every small error. It's natural to make a few mistakes each day, because trading requires a thousand real-time decisions. Often the best we can do is to limit damage and understand the types of brain cramps that rob our pocketbooks.

These popular errors run the gamut from mental blunders to misguided opinions. Not surprisingly, the most common ones also cause the most damage. For example, consider how much money your blind love of tech stocks has cost you in the last six years. We can't eliminate trading mistakes, but we can limit their destructive power. Start by listening to the little voice in your head, and let it question every trading decision you make. In no time, you'll find a dozen ways you're losing money for no reason.

Let's start with the trader who should have just taken the day off. There's nothing worse than trading trends in a choppy market, or choppy conditions in a trending market. So make sure you know the type of environment you're trading in before you hit the enter button. Most traders feel compelled to be in the market each day, even when we have absolutely no edge to play. This common impulse is also a major trading mistake, because it forces us into bad positions just for the thrill of being in the action.

The solution: Learn to sit on your hands when the trading gods have nothing to offer. Traders hate to lose money and don't want to admit it when they're wrong. So they press on with bad positions rather than cut their losses, trying to turn lemons into lemonade. Invariably this triggers a bigger loss than they would have incurred if they had just admitted the mistake right away.

Persistence in bad trades can turn controllable losses into uncontrollable disasters. The inability to cut losses is the major reason that traders wash out of the markets. The bottom line is that you don't know what your stock will do, despite all your research and commitment. So always be prepared to hit the exit button at a moment's notice. Traders also undermine performance by cutting profits on good positions. This is usually a self-denial issue, in which we understand at a subconscious level that we're in a great position. But for some reason we don't want the winning experience and exit with a small profit just before the trade would pay off in big bucks.

My most common trading mistake is being too early in new positions. I have a great eye for market direction but often hop on board well before that stock is ready to go anywhere. This puts me into a highly vulnerable spot where any small wiggle will shake me out for a loss. You see a great trade setting up and get all excited. But seeing a pretty pattern isn't the same thing as playing it for a decent profit. Timing is everything in the markets, and we get ahead of ourselves by jumping into positions that aren't ripe. So slow down and wait for the perfect moment to pull the trigger.

Of course it's just as easy to be late to the party. Being late means being unable or unwilling to pull the trigger, because you're waiting to see what everyone else does first. Unfortunately, everyone else is ready to get out of that stock by the time you're finally ready to get in. Being too bullish or too bearish will also cost you a fortune over the years. It's your job to come into the market without preconceived notions about price direction. I know this is hard to do when a thousand folks are talking their positions. But you need to fall back on the old wisdom of trading what you see, not what you believe.

Even smart traders show a dumb tendency to ignore the forces of gravity in their positions. We worried too much about gravity back in the 1990s, when everything was going up. Now we need to pay a lot closer attention to it. Simply stated, stocks go down when they can't find buyers, regardless of how few sellers are out there at the time. Stocks can fall for a very long time on low volume when they can't gather an enthusiastic crowd of investors or speculators These slow-bleed declines will cut right through common support and moving averages, despite everything you know about technical analysis. So learn to cut and run when gravity grabs hold of your position.

Finally what is the single biggest trading mistake of 2006? It's ignoring the big picture and acting on impulse. Although we're in a broad sideways range this year, legions of traders keep buying at the highs and selling short at the lows. You can solve this major mistake by stepping back at least once a week and looking at the weekly charts.

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