3 Ways to Combat Overtrading

01/21/2014 6:00 am EST

Focus: TRADING

Overtrading is a common affliction among traders, veteran trader Brian Lund of BCLund.com shares his ideas to avoid committing this cardinal sin.

I tend to look at the world through market colored glasses.

If I have to wait in a ridiculously long line at the grocery store because there are only two registers open, that’s an order imbalance to me. Too many buyers and not enough sellers.

Recently I took a much despised transcontinental flight. The day of my flight there was one first-class seat open, costing an upgrade fee of $750 dollars. When I boarded the plane it was still available—$350, I estimated, as long as the cabin door remained open. Forty-five minutes into the flight it was down to $110.

A polite request to the flight attendant and a smile, and it was mine for eight dollars. It hit my target and I hit the bid.

So, when I got an agitated call from a good friend of mine last week regarding a domestic matter, I naturally framed it in terms I could relate to best.

My friend and his wife both make a good living, but by the end of each month they always seemed to be in the red. The root of the problem appeared to lay at his wife’s feet, as she seemed to be the one draining the bank account on a regular basis.

Note: This is not meant to be some sort of gender biased comment; it’s just happens to be how the facts lay out in this case.

In order to find some sort of mutually agreed upon solution, he and his wife decided that they would not make any purchases over one hundred dollars without checking with each other. But despite the plan, by the end of the next month, they had still gone negative.

A quick look at their monthly statement told the story. His wife had indeed stuck to the rules of their agreement; but not the spirit.

There were almost 50 individual charges on her debit card ranging from $45 to $95 dollars apiece.

What I saw was over trading. And possibly a stint in couples therapy.

I have talked at length on this blog about the importance of a methodology and using position sizing to define your risk, but you can still blow your account out if you use “respecting your max loss rules” as a rationalization for over trading when you are running bad.

There are a couple of ways you can avoid that.

One option is to limit the number of trades you make in a given time period. For a daytrader, that might be two to five trades a day. For a swing trader that might be six to ten trades per month.

A second option is to set a maximum cumulative dollar loss for your account in a given time period, regardless of number of trades.

But no matter which method you use, the important idea is that it is based on tying individual position losses to your overall account equity. That way you have created objective criteria to let you know when you are over doing it and need to dial things back.

By Brian Lund of BCLund.com

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