Do You Know a Trading Mistake When You See One?

I found an interesting quote from Barry Ritholtz:
 

Good traders know that opportunistic speculation is a process. Ignore any one single outcome, focus on the methodology that can consistently avoid catastrophic losses, manage risk, preserve capital. A good process can be replicated, a random spin of the wheel cannot.

...if we expect to be wrong, then there will be no ego tied up in admitting the error, honoring the stop loss, and selling out the loser -- and preserving the capital.

This mindset doesn't only apply to speculation. It applies to all aspects of trading/investing. I've seen many beginners do something that doesn't turn out well, and immediately decide that they've discovered a trading rule to be used for a lifetime.

We all make decisions that could have turned out better. Many times such decisions aren't "mistakes" in the true sense of the word. It's a mistake to make a large investment in a business when you know nothing about that business. It's a mistake to turn a small loss into a large loss by being stubborn.

But it's not a mistake to make a trade and then see the stock market behave in a manner that wasn't anticipated. Believing that you can consistently predict where the market is moving, and when it will get there -- that's a mistake.

I know someone who failed to take a profit on one trade, watched that profit disappear, and has now devised a trading plan based on always taking profits when they reach that same percentage gain. He's seen far too few trades to make such a decision. That's a big mistake.

We all know traders who wrote covered calls, watched the stock rally, and -- forgetting the reason for writing the call in the first place -- got greedy and repurchased the call, only to see the stock move back to its original level. Sure, a trader can change his/her mind and decide to buy the call, but most people do that to "correct the mistake" of selling the call in the first place. It wasn't a mistake. It was a reasoned trade that gave a winning result, but not the maximum result. Buying that call option with no rationale other than "it was a mistake to sell it" is a mistake.

As a result, some people decide to never again write a covered call. That's an unreasonable conclusion based on a need to earn top dollar on every trade, and something that I categorize as a mistake.

When devising a trade plan or formulating a trading style that's expected to last your entire trading career, decisions must be made on more than a single event. Each trade offers another learning experience and data point that can be used. But no single trade should be used as the basis for a permanent trading plan. Gain experience, don't jump to conclusions, and as a result, you'll be in better position to devise a trading plan that's based on your own personal experiences.

Please don't assume that every time you lose money it's because you made a mistake. But don't always blame it on bad luck. Analyze your trade decision and decide whether it was appropriate. When you make a mistake, that's a learning experience. However, it's important to recognize the difference between a true mistake and a situation in which a trade didn't work.

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