June 03, 2008 at 6:30 am | | Comments 2

Skipping Trades Can Be as Bad as Overtrading

This guest post comes from a friend of mine, Dave Mabe of StockTickr, an automated trading and performance analysis tool designed to help traders improve their results. Dave’s post outlines the benefits of adhering to a trading plan, as well as the pitfalls of deviating from it.

Most traders are aware of the dangers of overtrading, that is, taking too many trades or trading with size that’s too large. Overtrading can quickly turn a reasonably bad day into a disaster. However, the less obvious problem of undertrading or skipping valid trades can be almost as bad.

If you’ve been trading for any length of time you’ve no doubt experienced it. A setup comes along that fits your trading rules just fine – but you find a reason NOT to take the trade. No harm, right? We all know what happens next – it runs and runs and had you taken that trade it would have been a nicely profitable trade. But you’re still sitting on the sidelines.

There’s More Lost Than Just an Opportunity

In the scenario described above, there is the obvious opportunity loss of a perfectly good trade. You could have made money on that trade, but you spent time warming the bench instead. But there’s a more important loss that is often overlooked. By skipping trades that meet your trading rules, you’re going to have an incomplete picture of your trading system’s performance. Think about it – when you go back and review your journal to gauge the performance of your trading system, you’re looking at the trades you took. If you’ve skipped trades that met your trading system’s criteria then those performance results are skewed and less meaningful than they could be.

It’s easier to imagine how a losing trade that you skipped can skew your results – when you review your trading metrics your system looks like it performed better than it actually did – it’s a little like looking through rose-colored glasses.

What Those Skipped Trades Might Actually Mean

If those skipped trades are starting to mount up, it might mean that your system needs a little more clarity. There are probably some additional trading rules that need to be more clearly thought through and applied to your trading plan. A well defined trading plan will allow you to be decisive and give you confidence to take trades that meet your critieria without hesitation. I’m not one of those guys that preaches that you need a fifty page thesis for a trading plan before you start making trades, but you do need a clear definition of the setups you’ll trade. You also need to be flexible enough (and humble enough!) to be able to look at your results objectively and make adjustments to your plan over time based on what the market and your journal are telling you.

“Small” Mistakes Can Often Lead to Bigger Ones

The seemingly benign mistake of skipping a trade can lead to more painful ones. Think about your worst trading days – many times they start with a small mistake that leads you into making larger trading mistakes that do put a dent in your trading account. It’s easy to slip into revenge trading after missing a good trading opportunity. Sometimes these skipped trades can snowball into a disaster.

Your Trading Plan is There For A Reason

Having a game plan is critically important. Without a well defined plan you’ll be subject to our human emotions which often encourage us to do the opposite of what is required for profitable trading. Take the trades that meet your criteria – no more AND no less.

Dave Mabe