The trading mistakes you wish you didn’t make

Buying an asset which has gone down in price can be dangerous

It is a common mistake among retail investors and those who are new to trading to want to buy an asset, such as a share, commodity or currency pair etc., which is “cheap” and sell one that is deemed to be “expensive.”

Vodafone Group PLC’s share price is a prime example. The stock has declined by over 16% year-to-date while the FTSE 100 only just slid into negative territory.

Vodafone versus FTSE 100 year-to-date comparison chart

Yet IG client sentiment shows that 98% of clients bought Vodafone shares and only 2% of clients have sold the share.

Over the past month there were 59% of buys, while the share price was slipping further, with more clients buying the share or adding to their long positions as they perceive the Vodafone share price to be even cheaper than it was before.

Vodafone Share Price Daily Chart

The problem with this approach is that if the share price continues to fall, as is likely to be the case as long as it remains in a bearish trend, the losses for the account holder accumulate and may trigger a margin call or even lead to the investor/trader running out of funds.

This may happen, even if the company doesn’t go bust and the investor turns out to be right over the long-term when the share price eventually recovers and leads to profits being made.

Human nature will in this instance more often than not lead to the investor/trader getting out of their - often emotionally painful - previously losing trade with a small profit, instead of letting their profits run, now that the share price is in an uptrend and therefore more likely to continue to rise than fall again.

What about short selling an asset?

The opposite is true with shares which have risen sharply and are thus deemed to be “expensive” or where inexperienced traders seem to think that these cannot continue to rally and thus short the stock.

A good example of this happening is the Nvidia share price which has year-to-date risen by a staggering 200%! Yet many investors didn’t want to buy the share earlier this year because it already had an expensive price to earnings (P/E) ratio and had risen by 50%, then 100%, 150% etc. Yet, here we are at +200% in six months!

Nvidia Share Price Daily Chart

The IG sentiment indicator shows that 57% of clients are short the share and only 43% believe that the Nvidia share price can rally further.

Sentiment indicators such as this one often act as a contrary indicator, meaning that when nearly everyone is long a share which is falling, it is likely to slide further, at least in the short-term, and vice versa for when IG clients as a whole are short, although this happens only on rare occasions as investors generally tend to prefer to be long.

What investors/traders should do

It may be psychologically difficult to buy an asset that has already risen sharply or over a long time but the odds of making money when trading in the direction of the long-term trend are greater than when trading against it.

Trying to find the bottom of a falling asset – also called bottom fishing - is like catching a falling knife and most of the time ends badly. The same goes for selling an asset that is in a strong uptrend.

When investing or trading financial assets, it makes sense to do so in the direction of the long-term trend and add to winning positions instead of adding to losing positions, as most investors do.

It may also be wise to use a stop loss order. That way, if the market were to trade in the opposite direction to a trader's position, the potential loss can be limited to, say 10% or 20% of one’s capital instead of risking all of it on the one trade.

Learning about technical analysis, risk- and money management in addition to one’s macro-economic outlook or fundamental analysis also usually improves an investor/trader’s success rate.