If you're a frequent trader, you might be tempted to do so in an effort to make rapid money. While it's true that constantly trading can boost your chance of making money, it can also have drawbacks. Your trading account may suffer if you overtrade, which is when you place too many trades quickly.
What is Overtrading?
Overtrading is the act of entering into too many deals quickly, frequently in an effort to make quick gains. Although trading regularly could seem like a good idea, overtrading can be detrimental to your trading account for a number of reasons:
Reduced profitability
There are a number of ways that overtrading can reduce your profitability. It may result in missed opportunities for larger market movements, lower trade profits, and eventually losses that outweigh gains. Overtrading can also result in unpredictable outcomes, which makes it challenging to keep up a disciplined trading strategy and ultimately hurts your long-term profitability.
Additional evidence that excessive trading can reduce profitability is provided below:
Missed opportunities: When you're trading all the time, it's simple to get distracted and pass up crucial market signals and openings. Focusing on quality rather than quantity allows you to take the time to find excellent trading opportunities that fit your strategy and raise your chances of success.
Risk exposure: Overtrading puts you at greater risk because every deal carries the possibility of a loss. You can control your risk more efficiently and prevent taking unwarranted risks by making fewer trades and concentrating on high-quality possibilities.
Undisciplined Behaviour: Overtrading can also result in a lack of discipline in your trading strategy. It can be challenging to keep your strategy and risk management consistent when you're making a lot of trades. This can result in rash trades or a lack of discipline, which would be detrimental to your trading performance.
Reduced trading performance: Overtrading may eventually result in a decline in trading performance. It's simple to get worn out or overwhelmed when you're making a lot of deals, which can result in errors and poor results. You may improve your trading performance and raise your chances of success by emphasizing quality over quantity.
You can also read: Drawdown: Understanding the Concept, Risks, and Examples
Increasing transaction expenses
You pay transaction costs including brokerage fees, commissions, and taxes every time you make a trade. Overtrading can cause several trades to be executed quickly, incurring significant transaction fees that eat away at your gains and may ultimately result in losses.
If you are overtrading, you might execute more deals than necessary, which would further raise your transaction costs. These transaction expenses can deplete your account balance and accelerate your loss of money if you are not profitable and are losing money on your trades.
To keep your transaction expenses in check and protect your trading account, it is crucial to have a sound trading strategy and to refrain from overtrading.
Increasing risk
Excessive trading can potentially make your portfolio riskier. Trading without conducting adequate research can result in taking on positions that are riskier than you would otherwise accept.
The following are some ways that excessive trading might raise risk in your portfolio:
Risk of concentration: Excessive trading can cause your portfolio's positions to become concentrated. You may be exposed to concentration risk if you make too many trades in a single industry or asset class. This implies that your portfolio may suffer greatly if that industry or asset class faces a slump.
Market risk: Excessive trading may expose you to further market risk. You can be more vulnerable to market volatility if you make too many trades. If the market goes against your positions, this could result in further losses.
Liquidity risk: Excessive trading may expose you to more liquidity risk. You can find it challenging to promptly exit your positions if you place too many transactions in less liquid stocks or during periods of low liquidity.
Execution risk: Excessive trading may expose you to more of this risk. You might not be able to complete your trades promptly or at the price you desire if you take on too many trades. Slippage may come from this, which could have a bad effect on your returns.
Behavior risk: Excessive trading can expose you to more behavior risk. If you place too many trades, you can be more likely to act emotionally and hang onto losing positions for an extended period of time or quit profitable positions too soon. Your returns may suffer, and your risk may rise as a result.
Signs You might Be Overtrading
Making impulsive deals, experiencing tension or anxiety while not trading, and closely monitoring the market and your trades are a few indications that you may be overtrading. It might be time to take a step back and reevaluate your strategy if you discover that you are making trades based more on feelings than on strategy.
How To Avoid Overtrading?
Start by creating a clear trading strategy that includes defined entry and exit points, risk management techniques, and a methodical approach to trading if you want to prevent overtrading. Keep to your goal and abstain from impulsive trades motivated by FOMO or emotions. Taking vacations from trading and concentrating on your long-term financial objectives rather than short-term earnings are also beneficial.
Conclusion
Your trading account may suffer from overtrading in a number of different ways. Through brokerage fees, exchange fees, taxes, bigger bid-ask spreads, and rebalancing expenses, it can raise your transaction costs. In addition, excessive trading might expose you to greater concentration, market, liquidity, execution, and behavioral risks. Therefore, to keep transaction costs and risk exposure in check, it's crucial to establish a trading strategy and refrain from overtrading.