Overtrading and Undercapitalization: a Trader's Plague

[Alchemist]

Overtrading, churning, churn and burn, twisting are all synonyms used to describe a situation of excessive buying and selling of stocks or other financial vehicles by a trader looking to pocket additional intraday profits or by a broker on behalf of an investor with the former interested in increasing his brokerage commissions.

Undercapitalization, on the other hand, is a term used to describe lack of proper trading capital by new traders making their first moves into the trading world, among several meanings. Undercapitalization as it applies to trading is brought about by the very common myth that you can start and succeed in trading with very little money, among others.

What do the above described situations have in common, you may ask! First of all, they are very common among brand new traders approaching trading for the very first time. Second and foremost, they can both negatively affect those traders’ chances of success at trading, and considerably lengthen their overall trading learning curve. Let’s see if we can jot down a few common sense rules to get those two out of the way!

Overtrading: do I really need to take this trade?

As already mentioned earlier in the article, overtrading as it applies to trading refers to excessive buying and selling of stocks. It’s worth adding that most of this unnecessary buying and selling behavior usually takes place during what’s well known among the traders’ population as dead zone. Dead zone as it applies to stock market trading is the period of time usually going from 11/11:30 NY time to 1/1:30 NY time. Dead zone hours are usually well known for their frequent head fakes, low liquidity, and increased difficulty reading stock moves. Do we really need to trade during that 2-hour window? Probably not. Overtrading during dead zone is usually brought about by traders’ boredom setting in and prevailing over anything else. There are several possible ways to try and cure this malady:

• Setting daily profit goals and maximum loss. Daily goals help build additional discipline. Once you hit your daily profit goal or maximum loss, you call it a day and go home. Tomorrow is another day.
• Stick to trading the first and last 2 hours of every trading session. Most of the money is made at the open and the close. Unless there are particular reasons to justify trading mid-day hours (news, etc), do yourself a favor by staying away from them.
• Wall Street old timers mentoring new traders usually advice them to go shopping during dead zone hours. You can do it too! If you get bored easily as 11 o’clock ticks, try getting out of the office and go shopping. You may even find something nice for your girlfriend!

Undercapitalization: you need money to make money.

Many new traders believe they can somehow get a shot at trading starting with very little to no money. This is a fatal flaw affecting many would-be traders. Unfortunately, there aren’t really any alternatives: you need money to make money. First of all, you need enough money to support yourself while you learn trading if you are doing this full time. Then, you need enough trading funds to take you through your learning curve which may vary from an absolute minimum of 6 months to a couple of years. Then, you need to take into account any money you spend on “trading education” other than trading losses J. That is, books, videos, premium services and any other educational material. You want me to add more?

Brand new traders must be prepared to apportion AT LEAST $25K as their starting trading capital and some additional funds depending on their lifestyles to support themselves through their learning curve. It’s also worth adding that new traders should assume zero or negative earnings during their learning curves as it’s very likely you will incur losses while learning the ropes. In addition, neophyte traders must avoid trading with money they cannot afford to loose. That is, money which was not originally intended for any trading activities (college funds, mortgage money, etc). I’m including a list of the most common “sources” of traders’ expenses, in an effort to really make it clear that you can’t start trading with zero money down!

• Trading losses during learning curve
• Trading commissions – whether you make or loose money on a trade, someone always gets their cut J
• Trading subscriptions (quotes, research, magazines, etc)
• Trading hardware (PC, monitors, graphic cards, etc)
• Connectivity (DSL, cable, T1, etc)
• Commuting costs if working from an office (car, subway, etc)
• Cost of living while learning trading – Who pays for your personal expenses?

[OverTheTop]

a combination of undercapitalization and playing with scared money was a major flaw in my early trading approach. Now I'm aware of the paramount importance of these two major trading concepts and I'm on my way to a healthy "trading recover"…….

[BlueChips]

been following this forum mostly as a lurker. I can't help saying excellent article!

[kika]

this is probably among the best articles I read on this website so far. Very nice and helpful!