The classic beginner mistakes
Many beginners' losses go back to a handful of mistakes that keep repeating. Once you know them, you've already covered a good part of the way.
Learning objective: After this lesson you can name the most common beginner mistakes and avoid them yourself.
The first mistake is impatience. People start before their emergency fund is in place and their debts are paid. The second is putting everything on one card, on a company or a coin you're rock solid convinced of.
Leverage as a mistake
The third is leverage. Almost every big beginner's loss has some behind it. The fourth is trading on feelings. You buy when everyone's excited and sell when everyone's scared. That way you buy high and sell low.
Chasing performance
The fifth is chasing. With every disappointment you switch strategy. After five switches you've paid all the costs and given no strategy enough time.
Winning losses back
The sixth is the most expensive: wanting to win back losses. Kevin loses €500 on a trade and bets double on the next one to get back to zero faster. If that goes wrong too, it's €1,500. That's how a setback becomes a total loss. There's a feeling behind it, not a calculation error. That's why only a rule you wrote down beforehand helps.
The mistakes can be traced back to a few patterns from behavioral research. Overconfidence leads to spreading too little and trading too much. Loss aversion leads to holding losers too long and selling winners too early. That's called the disposition effect. And because we overrate what we experienced most recently, after three good years we believe it will always go on like that.
Doubling down after losses
Doubling up after losses has a name from the casino: martingale. You win a little very often and rarely lose everything. Because the expected value doesn't improve and your own money runs out at some point, the method leads to ruin for certain in the long run. It's only a question of time until a losing streak is long enough.
Setting rules in advance
The best protection is committing yourself in advance. Write down rules for how big a position may be at most, when you bring your portfolio back into balance (rebalancing) and when you get out. You don't renegotiate these rules when it hurts. What matters is less that the rule is perfect. A mediocre rule you keep beats a good one you break.
Summary
- Big beginner losses often come from leverage or from putting everything on one card.
- Trading on feelings means buying high and selling low.
- A mediocre rule you keep beats a good one you break.
Did you get it?
What is the disposition effect?
The tendency to hold losers too long and sell winners too early.
Why does raising your stake after losses lead to ruin?
Because it doesn't improve the expected value and your money is limited. At some point a losing streak comes that eats everything up.
What does a rule written down in advance do for you?
You don't renegotiate it while you're under pressure.
Check your understanding
Your task
You have a $5,000 account, lose $300 on one trade, and put in double on the next, which is $600, and that is also lost completely. Calculate the loss in dollars and as a percent of the account. Then write down a rule for what you may and may not do on the day after a loss.
Sources and further reading
- Shefrin and Statman's original 1985 study, which first described the disposition effect. View source ↗
Related
- Capital preservation before profitStage 3
- Loss aversionStage 3
- Overtrading and revenge tradingStage 3
- Matching questions for this stageQuestions