3 Stock Trading Pitfalls to Avoid

The statistics at this point are no secret. Most traders either blow-up or stay in the red.

But why?

Well, usually it’s due to a number of factors, such as emotional trading or ignorant speculation, but even novice traders know these.

Here are three less-common pitfalls that even experienced traders fall into, and how to avoid them.

Average True Range (ATR)

ATR is a volatility indicator in technical analysis (i.e. charts). The formula for how to calculate ATR is actually quite complex; but thankfully, you don’t actually need a lesson on this right now.

What you need to know about the ATR indicator is this: hedge funds use it to set stop losses – and when their stops get triggered; you get crushed.

The way they use it to set stops is actually quite simple: they use a multiple of the ATR on the chart.

So for example, assume that the ATR on a daily chart on General Electric (NYSE: GE) is 0.386, which actually represents about .39 cents on this $11.32 stock.

Hedge funds will use a multiple of ATR to provide a sufficient allotment for expected volatility to avoid getting stopped-out too early, while also protecting downside.

A common multiple used for ATR is 3; so in the case of GE, that would be 0.39 x 3. = $1.17. So, wanna guess where their stop will be set? Around $10.15.

Now, here’s how you can use this to your advantage to avoid falling victim to an ATR-triggered sell-off that crushes your position.

Spend some time watching the panics and rallies of the stock you’re looking to trade, and keep track of what ATR multiples they tend to occur at most often.

Then you’ll know how to trade around them.

Power tip: Use a range of multiples (i.e. 2.5 to 3.) – and not hard figures. This is because algorithms and even human traders are constantly optimizing their stop strategies.

Volume Weighted Average Price (VWAP)

This one is a personal favorite. It as well is a technical indicator that you can add to your charts.

Again, you don’t need to know the history of this indicator or the formula, unless you really want to for bedtime leisure reading.

Here’s why you should pay attention to this one.

As the price of a stock gets further away from the VWAP level, statistically and theoretically, the odds of those two converging increase. Algorithms use this indicator, and huge moves occur within that range; thus crushing you.

In fact, I have made a proper fortune by out-maneuvering very large algorithmic platforms in the last hour of the day by going long/short on a stock right before they do and it just explodes the stock up or down.

Yes, I personally make this a man vs. machine effort, and as of right now, I’m beating the machine 80% of the time. It feels good, and I know John Henry is looking down on me with pride!

I’m not going to share with you my proprietary strategy for playing with this indicator; but you can actually use this one in a similar fashion to ATR: simply watch the VWAP of the stock, and the price points at which the stock pivots and the two converge.

If you do that, you’ll get better trade setups.

Power tip: Remember, if you are getting terrible trade entries, it’s going to be very hard to recover from that unless you are prepared to average down through the gyration, or hold for the long-term. So the point here is to make better entries!

Earnings

Lots of traders try to play earnings one of two ways. They either think that a particular company is going to release an earnings win and so they try to piggyback on that, or they try to get in the day before.

However, more often than not; they’ll probably lose, because traders forget that companies can buy-up their own stock leading up to earnings (either directly or indirectly), so when earnings are announced, the gains are either dismal, or the stock sells-off.

The way to avoid this pitfall is first remember that stocks are anticipatory of the actual event; so if a company is going to have a great quarter, there’s a very good chance most of that stock appreciation is going to be factored into the price BEFORE earnings.

So if you want to swing trade that move, start early.

Pro tip: You can use the same two indicators mentioned above for your entries on earnings plays (wink wink, you’re welcome).

Also, it’s important to keep in mind that if making a great living by trading was easy, everyone would do it and the benefits would be nullified; so instead of looking at the high failure statistics as a bad thing; realize that it’s necessary to have a high failure rate in order to produce uncommonly large returns if you can avoid the pitfalls.

This article will give you a leg-up on 70% of traders out there. Enjoy!

Blessings,

J. Patrick Nichols