Using an Inappropriate Strategy

A common mistake among traders involves using an inappropriate strategy, or worse still, having no strategy at all.

Using some type of strategy on a consistent basis, even a simple moving average cross-over system, provides a framework of discipline for the trader. This is generally going to deliver better results than a haphazard approach or the use of a constantly changing series of strategies.

Some care must be taken when selecting a strategy. It would be a mistake to attempt trading a strategy based on five minute charts if you are unable to access your trading platform for much of the trading day. Similarly, it would be a mistake to use a strategy based on monthly charts if your trading horizon is measured in days or weeks.

People tend to hold a belief that a more complex system must be a better system. This is especially true among certain groups of traders. They develop systems that employ huge numbers of inputs and require extremely complex calculations & algorithms. They often produce charts that are so heavily covered in indicators that it becomes difficult to see the price action. While some of these complex systems certainly can be profitable, the more inputs and calculations they require, the more potential there is for something to go wrong.

In many ways, a simple strategy is often better (and easier to follow with confidence) than a more complex system.

One of the tools employed by many strategies is the short trade. This is where a trader sells a CFD that they don’t currently hold in anticipation of buying it back again at a lower price in the future. While it can be argued there is little difference between taking a long position or a short position, the short position may not be appropriate for a highly conservative trader.

In theory, a short position holds much greater risk than a long position. This is because of the difference in the maximum potential adverse excursion for each type of trade. With a long position in a CFD where the underlying asset is a security, the worst possible move would be for the underlying security to fall to zero and become worthless.

For a short position, where losses will mount as prices rise, the maximum adverse excursion is theoretically unlimited. While holding a short position in a CFD where the price of the underlying security is skyrocketing is unlikely, it is a possibility. Accordingly, it might be considered a mistake for a highly conservative trader to trade on the short side, especially without a stop-loss order in place.

While some complex systems can be profitable, the more calculations they require, the more potential there is for something to go wrong.