Are You Under Or Overtrading?

One thing that all traders will eventually need to consider is how much should be traded. Will they make one trade per day, 100 or more? While how much to trade may just happen naturally, every trader should stop and evaluate how much they are trading and if they are possibly under or overtrading their specific style or system. Scalping styles generally require lots of trades, while positions traders need to be more selective in the movements the trade. Each style is different, and too many or too few trades could potentially harm a trader's profits.

Learn a Little About Yourself

The first thing you need to decide is what kind of trading you like to do. If having to watch every tick of the ticker and every change in the quotes would drive you crazy, chances are you don't want to be a scalper. If you like the high pace and being highly involved in the market every second of the day, scalping could be the way to go. If you like doing research or the idea of trading on news or major technical levels you might want to do less trades and focus on long term styles of trading. (Let's take an interactive look at equity research with The Changing Role Of Equity Research.)

You may also like the idea of finding a medium; not holding positions all day but not entering and exiting every few seconds or minutes either. You take part in the major part of a move, normally once it is already in motion (you can still do your research to find out where these moves might take place) and then exit as soon as it looks like the momentum may slow or shift. With this style of trading you may make up to several trades within the day depending on market movements.

Also, all traders have different restrictions or circumstances that will almost force them (at least temporarily) into one style or another, and scalping will generally not be the desired approach. Scalping requires extremely low brokerage fees as the trader will have to make many trades, mostly for a small profit and many may end up with many flat trades minus trade costs, thus resulting in a cumulative net loss. So unless traders can get their costs per trade down to a very low level, they may want to put scalping on hold. Most traders starting out will need to do fewer trades to control their fees, but they will attempt to make more profit on each trade. This will entail doing research on what stocks will move the next day, scanning for stocks that have hit, or are about to hit major technical levels, or stocks that will move based on economic data, news or other market driving force. Traders also have other commitments, sometimes other jobs, or family. The amount of trades being done should be congruent with other lifestyle choices. (To read more about different types of trading strategies, refer to Introduction To Types Of Trading: Swing Traders.)

Under or Overtrading

Next, a trader needs to be able see if he or she is under or overtrading. In other words, is the trader giving up potential profits because they are not willing to enter a position when they see an opportunity, or are they wasting money racking up excessive fees? If a trader is under-trading he or she will probably end up saying things like "My trading plan says I should get in, and I didn't!" or "Why didn't I make that trade?" This is a clear sign of undertrading.

Overtrading can be harder to pinpoint, but if the trader is consistently only making a couple of dollars above commissions, or is making random trades with untested methods, then he is likely overtrading. Another sign to look for is exiting too early in a profitable move, or placing stops too close to the entry price which pre-maturely exits the trader from a would-be profitable position. These will lead to increased trades and increased trading costs.

In both cases, the trader needs to structure a trading plan in such a way that will pull them away from these tendencies. (It's impossible to avoid disaster without trading rules - make sure you know how to devise them for yourself Ten Steps to Building a Winning Trading Plan.)

Use a Trading Plan

Every trader should have a trading plan. Entry and exit from stocks should not be random; there should be a reason behind each trade supported by the trading plan. Chances are, if a trader is overtrading or undertrading and a plan is in place, that plan needs tweaking. If they are overtrading they may need to make their entry and exit criteria more stringent or harder for the market to manufacture valid signals. When we add more criteria that need to be in place for a trade to happen, we will do fewer trades but chances are those trades will be more consistent and more profitable - although this is never a guarantee.

If a trader is undertrading, it is likely that there is no trading plan in place and he is just watching a stock and missing opportunities. If they do have a plan, their current criteria for entering a trade is likely too restrictive. If a plan does not allow the trader to capitalize on major movements it should be adjusted so they can take part in these moves.

Do not cut off valid market opportunities because of a fear of losing. Develop a plan of attack for the markets; what needs to happen in order for you to enter a trade, and also what needs to happen for you to get out of a position? (Learn more in Day Trading Strategies For Beginners.)

Summary

All traders regardless of how often they trade should have a trading plan. After the trading plan is in place we need to do a self-assessment of if we are over or under trading within our plan. Based on these results we can alter our trading plan to suit our needs and likely increase our profitability. If we are overtrading, we can make our trading plan more restrictive for entries and exits. If we are under-trading, we can relax our trading plan criteria to take advantage of potentially profitable moves in the market.