Can Overtrading Hurt Traders? How to Avoid It?

Nick Leeson, a former derivatives trader is the perfect example of what overtrading can do to your funds. The man lost over twice the total capital of Barring’s Bank, which had hired him. Although he was responsible for maintaining a cash-neutral business, not stopping when losses accumulated made him lose over £827 million. The incident led to the eventual bankruptcy of Barring’s Bank in 1995.

Having generated significant profits, young Leeson had won the confidence of banks analysts, who audited his trades only once a month. His mistake was that he went rogue by risking more capital than he should have and not stepping back when his trading plan seemed to not work in the ongoing market conditions. These are typical characteristics of overtrading.  Overconfidence in your ability to recover losses immediately can often lure you into turning your trading plan into a revenge tactic on the markets. Identifying and kicking the bad habit of overtrading in time is crucial for traders to protect their capital and last longer in the markets.

What is Overtrading?

Overtrading means risking more capital, taking positions more frequently, or surpassing your risk tolerance when placing trades. Simply put, it is when a trader abandons their trading plan to chase profits or take revenge on the markets. This leads to making a series of bad decisions. There’s no fixed threshold to the number of trades or amount of capital that marks overtrading. Experienced traders usually follow the rule of not risking more than 1% to 2% of the capital in their trading account on a single position. You can identify overtrading as a tendency to make impulsive, stress-based and careless decisions. Emotions lead you to ignore your trading plan. The results are often disastrous, wreaking havoc on your trading psyche.

Dangers of Overtrading

Overtrading hampers your trading experience in several ways.

Increases Transaction Costs

Each trade incurs costs – commissions, spreads, slippage. When you overtrade, these costs eat into your profits. When combined, a little extra slippage and wider spreads with overly frequent trades accumulate to increase trading costs.

Disturbs Trading Psyche

Overtrading is often fuelled by emotions, such as chasing quick gains, loss recovery, revenge trading and the fear of missing out (FOMO). These lead to impulsive decisions that cloud your judgment. When you continue to accumulate losses, they add to the agony, triggering more intense emotions and weakening your trading psyche. These result in greater impulsivity in decision-making.

Detracts From Your Trading Plan

Continuous trading to recover losses or out of greed is only a reactive technique. More importantly, it is an inadequate way to cope with the inability of your strategy to adapt to changing market conditions. Instead of a clear plan, you jump from one trade to another, leaving sight of the bigger picture – your trading goals.

Heightens the Risk of Ruin 

The more you trade, the more losses you might accumulate. A string of bad trades can quickly deplete your capital, especially if you don’t manage risks effectively. Overtrading amplifies risk, paving the way for you to wipe out your trading account or worse, get you into mountains of debt.

How to Check if You are Overtrading?

The following signs may indicate you are overtrading. However, it is easy to shrug them off as being paranoid than actually addressing them, especially if you have been overtrading for a while. It could be a good idea to track your trading performance in a trading journal. This will provide evidence of your trading behaviour.

Constantly Monitoring the Markets

Track the number of times you check market updates or the number of hours you are glued to the screen.

Making Trades Based on Hunches

Verify the driving force behind your trading decisions – is it your trading strategy, market signals, or a gut feeling?

Feeling Anxious or Stressed About Trading

Consider how you feel about opening a position right when you are about to hit buy/sell. If you are scared or unsure of placing a trade, you might be making an impulsive decision.

Compelled to Skip Journaling the Trades

This is a subconscious decision to escape the embarrassment of poor trading habits. This indicates a lack of acceptance of opening poorly planned positions.

How to Avoid Overtrading?

Whether you have noticed your overtrading tendencies, been warned by a friend or are trading well within your means, these tips to avoid the bad habit can be helpful.

• Creating a trading plan spanning months or years and not just days and weeks. Long-term planning gives perspective and reduces pressure.
• Stay within your trading capital and time limits. You can create weekly limits to have some flexibility. A good exercise is to fix a ratio of trading hours to breaks.
• Practice mindfulness and strategies to keep calm. Learn more about maintaining a balanced trading psyche. 
• Maintain and monitor your trading journal regularly. Schedule self-reflection time weekly or monthly. Ensure you remain objective and do not find yourself justifying bad trades.
• Seek education and mentorship. If that does not fit your trading style, you can form accountability partners to keep you on your trading plan.

Mindfulness is Key

Overtrading can mar the careers of even the most promising traders. By understanding the dangers of overtrading and adopting strategies to avoid it, you can save significant capital. More than that, you save yourself from a lot of guilt and regret. Discipline, patience and a well-defined trading plan are your best weapons against market uncertainties.

To Sum Up

• Overtrading leads to increased costs, emotional distress and deviation from trading plans.
• You must observe your trading habits to identify signs of overtrading.
• Overtrading can deplete capital and damage reputation. 
• Discipline, patience, and a solid trading plan are crucial to avoiding overtrading.

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