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What it is and how to avoid it

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Overtrading is one of the most common ways of a trader at any level—beginner or experienced — can sabotage their performance. However, traders do not always realize that they are overtrading. Instead, they blame it on other factors, and worst of all, try to fix it by overtrading more!

If I overtrade without knowing it, the behavior can quickly turn into a negative spiral that destroys my account.

To tackle the problem of overtrading, I answer the following questions in this article:

  1. What is overtrading?
  2. How do we identify it?
  3. How do we fix it?

Let’s get started.

To make money in the markets, I have to enter trades. If I don’t trade, I make zero dollars. So, I need a critical mass or a minimum number of trades to make enough profit to make my efforts worthwhile.

Overtrading occurs when I trade beyond the conditions that have made me successful. It’s hard to tell when I’m crossing the line into overtrading because it’s a continuation of the successful behavior I need to make money.

Let’s use food as an analogy: I need food to stay alive. However, if I overeat or eat the wrong kinds of food, I will worsen my health and even shorten my life. Still, I can’t cut out food completely because I need it to function.

Overtrading is similar. I have to trade to make money in the markets, but I can reach a level where the behavior becomes unhealthy.

What causes excessive trading?

Ultimately, overtrading is caused not having discipline and successful business plan. There are several triggers, and while this is not an exhaustive list, here are some of the main causes of overtrading that I have observed:

  1. Provided that money should always be in the market. There will be quiet periods when the strategy does not produce any trades. It’s easy to feel like it’s automatically bad because not being in the market means not making money. However, a critical part of trading is knowing when conditions aren’t right and when it’s better to stay out of cash.
  2. Fear of Missing Out (FOMO). FOMO is a classic psychological problem in all walks of life and I would be surprised if there is a human being on this planet who has never experienced FOMO. So it’s no wonder that traders in the markets are feeling the FOMO. When the markets are moving, it’s tempting to want to be part of that movement, even if it means jumping impulsively in a way that doesn’t match the trading plan.
  3. Boredom. Sometimes people just crave action. The boredom of waiting for a trade to line up is a real trigger for entering trades without the right conditions and eventually overtrading.

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They exist many different ways to retrade– let’s look at the most common ones:

  1. They follow market movements. This is a symptom of fear of missing out (FOMO). After a big price move, it’s tempting to jump into the market for fear of missing out on the next event. But FOMO-triggered deals ignore whether it’s a good entry. For example, stop loss it can be too far, causing a terrible reward-to-risk ratio.
  2. Trading in more volatile markets. Higher volatility it is attractive because of the potential profits from larger price movements. A certain volatility is necessary for making money. But the market doesn’t have to be more profitable just because it’s more volatile – it depends on trading skills and strategy. If I can’t profit from these markets, I should leave them alone. Otherwise, I’m acting out of FOMO and will probably trade.
  3. Store sizes too large. This is a unique type of retrading because it does not involve placing multiple trades. Instead, it means investing too much capital or risk in individual trades. This is a sign of greed – imagining the profits if the trade wins. You should always consider the consequences of the size of the loss if the trade loses.
  4. Taking advantage of weak opportunities. With any strategy, some opportunities are stronger than others. Especially in discretionary trading (i.e. not systematic or mechanical) it is easy to fall into the trap of accepting weak setups that do not quite meet the criteria of a trading plan due to impatience or a desire for more activity.

I wouldn’t discuss overtrading if it didn’t affect performance, but what exactly is the impact of overtrading?

  • Lower profitability. Excessive trading results in poorer quality trades, for example with a lower probability of achieving profit targets or worse reward/risk ratios.
  • More shops mean more costs. Every time I trade I pay a spread or commission. Higher number of trades means higher trading costs. What’s the point of paying fees for bad trades?
  • High trade sizes can kill an account. It is common to hear of one or two trades destroying an account because the position sizes were too large. Risk management is fundamental to long-term business success.
  • Spend more time managing trades. Time is valuable and should be spent in areas that create value. Excessive trading commits time to low value activity.
  • Not knowing what creates success. When over trading, I may not know what types of trades or markets produce success, which prevents me from improving.

The 80/20 rule

The Pareto principle states that roughly 80% of the effects come from 20% of the causes (“the few vitals”). The Pareto principle is also known as the 80/20 rule or the law of the vital few.

Applying the Pareto principle to trading means that most profits come from a select few trades. The numbers don’t have to exactly match the 80/20 split, but it’s a general rule of thumb.

The Pareto principle can also apply to markets or strategies. For example, if I’m trading 5 or 6 markets, I might find that 1 or 2 of those markets are producing the majority of profits. If I’m trading different chart patterns or strategies, I might find that 20% of those strategies produce 80% of the results.

Overtrading works against the 80/20 rule

Excessive trading takes us in the opposite direction of the Pareto principle—instead of focusing on the trades that bring in the most profits, overtrading adds more trades to the mix and reduces performance.

There are steps anyone can take to minimize excessive trading behavior and improve performance.

Step 1: Have a written business plan.

Retrading means accepting trades that are not part of a business plan. To combat overtrading, the first step is to know when to trade by following a trading plan. The trading plan should include entry rules, exit rules and risk control. The clearer the trading rules, the easier they are to follow.

Step 2: Keep a business record or journal.

It helps in keeping accurate and detailed records identify which trades are profitable versus those that should be cancelled. It also tells me how often I receive trades that are not part of the plan. Sometimes just knowing that I have to explain my actions in the journal prevents me from taking a trade that is a weak setup or not part of the trading plan.

Step 3: Review your trading records and journals.

After step 2, look for patterns in the results. What types of business are most successful? Are specific markets not profitable? Are there days of the week or times of the day that are not profitable for day traders? There are many online business magazines that can help create and analyze this level of detail. My favorite online business journal is “Edgewonk”.

Step 4: Reduce risk or stop trading when you overtrade.

If someone finds that despite their best efforts, they routinely overtrade, such as by trading when they are bored or nervous, it is a good idea to reduce risk or demo trade until they are in a better routine. It is important to protect hard-earned capital.

Step 5: Test new ideas before implementing them.

Of course, it’s okay to want to add more profitable trades. I can add new markets, strategies or even shorter timeframes. But I should test ideas with less risk on a trade or on a demo account before starting real trades with normal position sizes.

Overtrading can easily happen because it is born out of a good intention to place more trades to make more money. However, the relationship between more trades (or larger position sizes) and profitability is not always positive. After a certain point we experience the law of diminishing returns where adding more trades means making a little less money or even starting to lose money with more trades.

Overtrading happens for several reasons: chasing the market after a big price move, fear of missing out by not trading volatile conditions, or being bored or anxious during calm times.

To combat overtrading, the first step is to know when to trade by following a trading plan. Keep a journal to see how often you trade outside of your trading plan.

Check your business records regularly. For example, a day trader may find trading on specific news days unprofitable, so they should cancel trading at those times.

Remember the Pareto principle, which states that roughly 80% of our consequences (or results) come from 20% of our causes (or actions). This principle suggests that we can cancel many of our trades because they produce marginal or negative results.

It’s okay to want to add more trades by adding more markets or strategies to help you make more money. Be sure to test these ideas first before fully implementing them.

What is overtrading?

Excessive trading means taking an excessive number or types of trades that do not contribute to profitability or performance.

What are the main causes of excessive trading?

The main causes include Fear of Missing Out (FOMO) after a big price move, chasing the market or trading out of boredom.

Why is overtrading a problem?

Excessive trading negatively affects the performance of poorly performing or losing trades and increases the cost of trading through extra spreads and commissions.

How do you control excessive trading?

Keep a trading journal to track trading activities. Check trading records regularly to see if strategies, markets or times of the day are not making money and eliminate those trades. Test any new strategy or markets on demo accounts or smaller positions before full implementation.

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