Seven Common Pitfalls that New Commodity Traders Fall Into
No matter how many trades I make or how many new traders I speak to one thing that never ceases to amaze me is the extent to which novice commodity traders make the same mistakes. Perhaps, what’s even more interesting is that I too made similar misjudgments on my first trades.
So today I’d like to share seven of the most common missteps that new traders make during their initial trades.
What are Commodities?
Commodities are simply physical goods that are exchanged as investments. They are desirable in the sense that they are highly demanded products that investors trade daily. Among the most popularly known commodities are farm produce, precious metals, and oil. Currencies are also considered to be commodities.
Why Invest in Commodities?
There are many reasons that investors invest in commodities. The first of which is that they are always in demand. Other reasons that investors like this type of investment is that they can:
· Help Offset Inflation
· Represent a Great Way to Diversify One’s Portfolio
· Provide Greater Liquidity to Investors
· Leverage to Investors Who Trade on Margins
· Have the Potential to Deliver Substantial Returns
Over the years, these advantages have attracted many investors to the commodities market, and if you’re reading this, there’s a good chance that one or all of these benefits appeals to you, as well. However, as you are about to learn, if you are new to commodities there are a few things you must learn before making your first trade.
Mistakes Beginning Traders Make
While the lure of commodities trading can be very enticing to beginners, if you’ve never done it before commodity trades can be highly risky. Namely, because when you’re starting out, it’s so easy to make mistakes. Here are a few of the most common mistakes that new traders make.
1 — Lack of a Game Plan.
Perhaps the most common mistake made by almost every beginning trader is that they begin making trades before having a roadmap in place. As with any investment, commodities trading requires a clear and well thought out strategy that outlines how you intend to address certain occurrences. Take crops as an example, if your knowledge of seasonal supply and demand leads you to believe that potatoes might spike in value, you’ll need to develop a plan that helps you get out before the price drops.
It’s also prudent to know where to put your gains when your predictions work out to your advantage. Likewise, having an idea of what to do if your trades incur losses is also wise.
2 — Poor Money Management.
Most trading beginners focus so heavily upon reaping a huge windfall that they fail to see anything beyond the next profit. Doing so causes novice traders to make poor decisions, which in turn can negatively impact their finances. However, what you must keep in mind — as a new trader — is that it’s not so much the returns that you should focus on; it’s the probability of losses or gains that really matters.
So, what you’re really looking for when trading commodities are circumstances or trends that favor or obstruct the commodity that you’re trading. Hence, even if a potential trade stands to net you five or six times your initial investment you must first look at the success rate to determine how close you are to generating a profit. If after further inspection you find that the likelihood of generating a profit is slim, turn and run as quickly as you can.
3 — Failure to Use Protective Stop Loss Orders.
If you want to avoid losing your shirt, protective stop or loss orders are paramount. However, many new investors fail to utilize stop-loss orders. As such, by the time they realize that they’ve lost money it’s often late in the game, and they’ve accumulated huge deficits.
One thing to keep in mind is that there are two types of protective stops — a self-imposed stop and stop-loss orders that you place with your broker. Many investors have subconsciously become accustomed to mentally stopping when a certain limit has been reached. Using stop losses, whether self-imposed or market orders can help avert massive losses.
Whichever variety you use, be sure to maintain strict self-discipline and know when to walk away from a trade. Otherwise, you stand to lose big in even modest market corrections.
4 — Not Cutting Your Losses.
Another disastrous mistake that traders often make early on is continuing to trade even in the face of persistent losses. The rationale is that the commodity will rebound and when it does they’ll be able to make up for any shortfall. However, what if the commodity never bounces back? That’s the problem with this approach to trading.
Of course, the good news is that if you already have a protective stop-loss order in place, you shouldn’t have to worry about mounting losses. But if you don’t plan to use stop-losses, you’ll certainly want to pay close attention to your positions and take immediate action to minimize losses.
The important thing is never to allow your losses to accumulate in hopes of better days ahead.
5 — Trading Undercapitalized.
New commodity traders often push themselves beyond their comfort zones, and they do so much to their own detriment. As a trader, you must always be prepared financially; this means understanding what you’re committing yourself to and making sure that you have the financial resources necessary to complete your trades.
Again futures trades involve significant risk as you could lose it all in the blink of an eye. So don’t be that trader who after putting nearly everything into his margin account loses it, only to go back again for more.
6 — Overtrading Your Account.
Overtrading is one of the worse things you can do as a new trader. It often starts with novice investors thinking to themselves, ‘the more I trade, the more I can profit.’ However, what they don’t realize is that more open positions equals more exposure. These risks can come in the form of heavy losses or debt that comes about as a result of being over leveraged.
Either way, it’s best to exercise caution when trading and the simplest way to do this is to hold your trading activity to a pre-determined limit.
7 — Being Impatient.
Another pitfall that many beginning traders fall into is being impatient. Acting before you’ve had time to vet your assumptions can cost you. As such, you should always ‘look both ways’ before making a trade as not every trade will yield massive profits. However, as long as you exercise due diligence while building and working your plan you should be able to build a strong portfolio.
And remember just because a commodity is trending doesn’t mean you should dive in for the trade. Make sure you’re comfortable with the fundamentals driving the trend before taking action.
Now that you have a clearer understanding of which pitfalls to look out for I hope that you’ll be in a much better position to avoid the mistakes that I made as a new trader.