Everyone makes the mistake of taking "low quality trades." Before you make your next trade or investment, make sure you’re not falling into the following trap highlighted by these excerpts from Trader’s U…
Low-Quality Trades: Lots of Activity, Little to No Profit
Have you ever taken a trade or gotten into an investment that you knew was not that great as soon as you entered?
I’m sure that you recognize it – one of those trades or investments that didn’t quite meet all of your set-up and entry requirements, but you took it anyway. I call these "low-quality trades." These are the positions that even the most experienced professional finds on his trade blotter every once in a while. They are the "fodder" of the trading industry. I really like that word – fodder. Webster defines it this way:
fodder (n): inferior or readily available material used to supply a heavy demand
And that’s just what "low-quality trades" are. They are inferior to the high-quality trades that we all long to make each time we open a position. And they certainly are readily available – you can take a low-quality, coin-toss type of trade any time you like. But the key for traders and investors who find themselves taking low-quality trades is found in the last part of Webster’s definition – "used to supply heavy demand."
When you take a trade of dubious quality, what demand in your life is it supplying? Why are you taking a trade that doesn’t measure up?
Are you bored?
Do you need the action of trading, even at times when a high quality trade doesn’t exist?
Do you believe that success only comes from hard work or furious activity?
Are you frustrated by your last trade or trades, and trying to "take it out on the market?"
Are you trying to make up for losses that you took earlier in the day, month or quarter?
Does your broker need some new equipment for the family yacht?Low-Quality Trades: Spyware for Your Brain
For many people, managing low-quality trades is the biggest drain they have on their profit potential. Why? Let’s look at the real costs associated with low quality trades.
As a reminder, low-quality trades are those that don’t quite meet your set-up and entry requirements. These are the trades where you "relax" your entry rules, and trade on a tip, or just because the market is in the middle of a big move and you don’t want to miss it.
These marginal trades tend to be more like coin flips. Here are just three ways they hurt us:
1. Spyware for your brain. Managing low-quality positions dilutes the attention and resources that you can apply toward finding and executing higher-quality trades. This "opportunity cost" of taking marginal trades can be quite high if it makes you miss some really good trades or investments. Managing low-quality trades eats up a large part of your brain’s processing power. Just like spyware. At the least, they’re a distraction. At worst, they command your complete attention and keep you from finding and executing more profitable opportunities.
2. Eaten alive by transaction costs. While low-quality trades chew up your mental energy, the transaction costs of these trades (slippage and commissions) eat up your account’s equity. Even if they’re 50/50 trades, they will consume your account little by little. Let’s look at an example…Say you make five low-quality stock trades per month, just to keep yourself from getting bored. With a $10 commission per side, and a $10 slippage getting in and getting out, you are spending an extra $200 per month, or $2,400 per year just on transaction costs! And if the frequency of your low-quality trades is worse, or your commissions and slippage are higher, this figure can balloon from there.
3. The physical and emotional cost. No one needs more stress in their life. But many of us add the stress of managing bad trades to our already taxed system. As we’ll discuss next week, many low-quality trades are born out of stressed states when we are more prone to let our guard down.
Trading and investing have plenty of challenges of their own – without adding the costs of taking low-quality trades that we really shouldn’t be in.