Don’t Overtrade is apt advice, particularly in the context of stock market trading and sometimes even in investments in the financial assets. However, overtrading is a malaise which afflicts a number of traders and operators in the stock market, as also operators and traders in other markets like the commodities market.
The concept of overtrading may be clarified through a discussion.
Let us discuss the problems associated with overtrading. There are many problems but ultimately it boils down to buying stocks or futures at “credit”. At first, it may sound a bit bizarre. To clear the issue, an example will be useful. Most of the persons buy provisions and pay for utilities in cash, but while going for costlier things like a car they take auto loan. Similarly, for buying a house, people generally take mortgage loans instead of making outright payment in cash (or by cheque). Now, let us take a live example of buying in the stock market. You are in the market, and you want to buy stock futures worth 100 $. You have two options – to pay 100 $ and buy the stocks. There is an alternative though – to pay a fraction of 100 $, say 20 $, and own stocks or futures valued at 100 $. The risk is yours and by investing 20 $, you are controlling stocks or futures worth 100 $, but at the same time you are taking risk for 100 $. If the value appreciates, your earning shall be fabulous compared to the amount invested. However, if the value deteriorates, your losses shall be high and a 20% slide in the value (not uncommon in markets like stock markets) will wipe out the capital, that is, 20$ in this case. Thus, the overtrading, directly or indirectly, has the potential for huge loss though it may result into huge profits too. But, one should err on the side of caution as an old saying goes, and so one should avoid overtrading.
- Trading Rules - a book by William F. Eng dealing with 50 Stock Market Trading Rules