Dubai: It can be tempting to keep trading in hopes of making better or bigger profits, but overdoing it can prove costly too. This is ‘overtrading’. In order to avoid this, an investor should make a minimum number of trades in a day without losing more money than what he or she can afford. But how?
If you are aiming to buy and sell your investments for short-term profits, such as within a week or a day, as opposed to holding onto your investments for a long term and selling them after years, there is a common tendency to go overboard, flag veteran investors and market experts.
How to find out if you’re an ‘overtrader’?
“If you find yourself ‘overtrading’, pinpointing the reason or cause enables you to take the actions necessary to trade better,” said Zubair Shakeel, an investment advisor at a Dubai-based wealth management firm. “Find out if you’re making investment decisions due to fear, greed, or revenge.
“When prices move quickly, you are likely to overbuy without thorough research or analysis. Also, on the first sign of profit, you may make more transactions to generate more returns. You may also excessively trade to compensate for a significant loss or a series of small losses.”
Brody Dunn, an investment manager at another asset advisory firm in the UAE, explained that overtrading often comes with certain signs for investors or traders to identify they are too frequently investing in their securities and assets.
Signs of overbuying or overselling investments
“If you have low-quality investments that decrease your returns or often buy or sell assets too quickly or in a tight price range, these are signs your actions are hurting your profits. In other words, your trading frequency is counterproductive to your investment objective,” added Dunn.
“Besides knowing the signs of overtrading, one must look at the effects. For instance, the more you trade, the more you pay in brokerage fees without observable results. As a result, you are highly likely to incur substantial losses.”
However, on Thursday, the price slipped to Dh51, so Adam sold them again. Adam lost both times he bought and sold the stock owing to ‘overtrading’. If he had bought the shares at Dh50 on Monday and sold them at Dh51 on Thursday, he would have still made a profit.
‘Overtrading’ is key reason behind investor losses
‘Overtrading’ is cited as one of the major reasons behind the losses that investors incur nowadays, according to multiple market studies conducted worldwide. But how many trades is considered ‘overtrading’?
“While the practice of excessive trading or ‘overtrading’ involves placing too many trades, the definition of ‘too many’ varies from one investment trader to another. There is no fixed number,” explained Shakeel.
“The answer depends on multiple factors, for example, the individual’s trading style, knowledge, experience, and specialization. For instance, placing 40 buy and sell orders might be manageable for one trader, while another individual might not be able to carry out more than ten trades.”
‘Undertrading’ just as costly a mistake as ‘overtrading’
Dunn explained that in order to fulfil investment objectives or financial goals quickly, ‘undertrading’ and ‘overtrading’ are both investment practices that investors would want to avoid. You ‘undertrade’ when you hardly trade, even when you have opportunities to buy or sell in the market.
“Both ‘undertrading’ and ‘overtrading’ are two terms that can confuse traders new to the investing in the market. Therefore, understanding the critical differences between the two practices is vital to strike the right balance between them,” he added.
“The primary cause of ‘undertrading’ is the fear of losing funds. While with ‘overtrading’, investors use their funds too frequently, but with ‘undertrading’, investors do not utilise their funds often and have very few investments they are looking to sell immediately.”
How to avoid the costly mistake of ‘overtrading’
According to Shakeel and Dunn, here are two steps you can take to protect your investments from losses that stem from ‘overtrading’.
1. Set a daily or per-session trading limit and stick to it
“If you consistently find yourself ‘overtrading’, consider making a rule or daily limit to keep your trading tendencies in check. For instance, traders can create a rule that they will only place up to three buy or sell orders in a session or five trades per day,” added Shakeel.
“As it is common for emotions like anger, greed, fear, and revenge to cause traders to make the wrong decisions leading to significant losses, creating a well-defined trading plan and sticking to it can help fulfil your investment objective – both in the short and long run.”
2. Pre-set options like ‘stop-losses’, ‘take-profits’ limit losses
One of the most effective ways to avoid ‘overtrading’, according to Dunn, is to use trading options like ‘stop-losses’ and ‘take-profits’ orders. These are predefined buying and selling points that automatically exit your investments when the price or investment loss reaches a certain level.
‘Take-profit’ is another type of limit orders that are closed when a specified profit level is reached. Take-profit orders are beneficial for short-term traders or investors interested in profiting from a quick bump in prices.
So while ‘stop-losses’ protect you from losing more than you can handle, ‘take-profits’ lock in your profits and prevent you from giving them back.
“To avoid overtrading, you need to use ‘stop-losses’ and ‘take-profits’ that are aligned with how much risk you can take on and how long you plan on staying invested. Don't move them randomly, don't ignore them, and don't hesitate to use them,” added Dunn.
Key takeaways
Overtrading is a common problem among traders, especially beginner investors, who tend to trade too frequently, too emotionally, or too aggressively. “Often times, low-cost brokerages encourage traders to invest more frequently in stocks, thereby making them vulnerable,” said Shakeel.
“You invest randomly when you go overboard. This reflects on your inability to assess the market, but you keep investing as you have to pay lower brokerage charges anyway. This frequent investing leads to frequent losses.”
When you realise you are excessively trading, Dunn suggests taking a short pause or step away from trading on the market. “A break from trading always helps regain control. This is a crucial skill, and honestly, it is one of the most difficult ones to learn for any investor – experienced or not.
“One of the main dangers of ‘overtrading’ is the effect it can have on your overall cash flow. Once your savings dry up then you can quickly find yourself in serious trouble. Diversifying your investments across different categories helps minimise risks,” added Dunn.
So by diversifying your investments or counter-balancing your risks between investments that have high and low risk, if you see a big loss in one category of investment, your losses can be covered in another, better performing section.
