What is Overtrading?

Overtrading can be broadly defined as when traders engage in too many buy and sell transactions. This situation often arises as a result of trades made unconsciously and without a clear plan. It is a common mistake, especially among beginners.

One of the main reasons for overtrading is the perception that the market constantly offers opportunities. Investors believe that every price movement presents a profit opportunity, leading them to frequently open and close positions. However, these trades are often executed without properly analyzing the market or following a solid understanding, which can result in both psychological breakdowns and financial losses.

In this article, we share detailed insights on overtrading.

Types of Overtrading

Overtrading may occur in 3 types:

• Discretionary
• Technical 
• Shotgun 

Let’s review them one by one:

Discretionary Overtrading

This occurs when traders make frequent buy and sell transactions within short periods of time. It typically happens as a result of overreacting to price fluctuations. Traders see every small price movement as an opportunity and this leads to unplanned trades.

Technical Overtrading

This happens when traders rely too much on technical analysis signals and engage in constant trading. Overtrading based on misinterpreting weak patterns or incorrect signals can lead to deviating from the strategy and result in losses.

Shotgun Overtrading

This occurs when traders engage in constant trading without a clear strategy. In this case, traders attempt to capitalize on every opportunity they see, regardless of its merit. It usually leads to unplanned and lower-quality trades.

How to Spot the Signs of Overtrading?

Overtrading can have both financial and psychological consequences. If you're frequently losing money or constantly feeling the urge to trade, these can be signs of overtrading. Below are some key signs that may indicate you're overtrading:

• You find yourself constantly monitoring market movements and feel the need to trade at every price change.
• You frequently open and close positions without a strategic plan.
• Your trading costs, including commissions and/or spreads, are starting to outweigh your profits.
• You make rushed trades in an attempt to recover losses or feel a fear of missing out on market opportunities.
• Most of your trades result in losses, and your overall performance is declining.
• You overreact to market news and small price movements, making trades based on these factors.

Causes for Overtrading

• Traders may tend to trade continuously due to the fear of missing out (FOMO) on market opportunities.
• They may make rushed and emotional decisions to recover their losses.
• The absence of an investment plan or strategy can lead investors to make random trades.
• Overreacting to market news and small price fluctuations can cause investors to trade frequently.
• The desire to gain quick profits can drive investors to make constant trades.
• Leverage trading may encourage traders to open more positions.

Who is at Risk of Overtrading?

• Inexperienced new traders may trade continuously out of fear of missing out on opportunities. A lack of strategy and discipline can lead them to open positions impulsively.
• Additionally, day traders or those seeking short-term gains may feel the pressure to constantly trade in order to seize opportunities. This often leads to unplanned and excessive trading.
• Investors who react emotionally to market fluctuations may engage in overtrading in an attempt to quickly recover their losses. This usually results in further losses.
• Moreover, traders who view market movements as a form of gambling may feel the urge to trade continuously in hopes of gaining profits. This mindset increases the risk of overtrading.

Effects of Overtrading

• It leads to accumulating costs from commissions and spreads for each trade.
• It can reduce an investor's overall performance due to unplanned and rushed trades.
• The constant need to trade can negatively affect an investor's mental health. Excessive stress, fear, and greed can make rational decision-making difficult.
• It causes investors to deviate from their strategies and fail to properly analyze market conditions.
• It makes achieving long-term goals more difficult.

How to Avoid Overtrading

To avoid overtrading, it's essential to stay disciplined, stick to well-defined strategies, and avoid emotional decisions. Below are some methods that can help you steer clear of overtrading:

Create a Planned Investment Strategy

Sticking to a well-thought-out investment plan helps you avoid unnecessary trades. Ensure your strategy includes details such as under what conditions you will trade, when to open and close positions, which assets to focus on, and risks you can bear.

Keep a Trading Journal

Record and analyze every trade you make. Reviewing your success rate and mistakes will help you achieve better results.

In your trading journal, note why you opened a position, the market conditions, and when you closed the trade. Analyzing your success rate will help you understand which strategies are working. It also helps you identify emotional or impulsive trades that lead to overtrading.

Avoid Emotional Decisions

Rushing in response to market fluctuations is one of the biggest causes of overtrading. The urge to recover losses quickly or the fear of missing out on opportunities often leads to unnecessary trades.

To avoid emotional decisions, ensure that your trades are based on logical and objective analysis. Not overreacting to market ups and downs is an important aspect of being a successful trader.

Set Goals

For each trade, set reasonable profit targets and stop-loss levels. Setting these goals helps you manage your trades more disciplined and reduces the need for excessive trading.

Stay Away from Market Noise

Avoid overreacting to news, rumors, or minor market movements. Basing your investment decisions solely on such information increases the risk of overtrading. By staying away from market noise, you can remain focused on your strategy.

Why Should You Avoid Overtrading?

Avoiding overtrading is important for traders both financially and psychologically. Overtrading often leads to impulsive and unplanned trades, which can decrease profitability. It also erodes your earnings by increasing transaction costs and commissions. Since each trade carries a higher risk, investors may experience losses in a short period of time.

Overtrading also negatively affects an investor's psychological state. The pressure to constantly trade can trigger emotions like stress, fear, and greed. This makes it difficult to make rational decisions and can lead to emotional trading. Emotional decisions usually result in further losses, weakening your motivation and psychological resilience.

Additionally, opening and closing too many positions can disrupt your plans on a certain trading instrument. Overtrading can distract traders from their long-term goals and push them to take unnecessary risks in pursuit of short-term gains. 

FAQs on Overtrading

What are the psychological effects of overtrading?

Overtrading can increase stress levels and weaken an investor's ability to think rationally. This emotional stress can lead to more mistakes and poor decision-making. Trying to recover losses quickly can push you to take more risks, increasing your losses.

How can you differentiate market noise?

Market noise refers to speculative news, rumors, or price movements that cause short-term fluctuations. To distinguish noise, base your analysis on long-term trends and fundamental data. Rather than reacting to market noise, just stick to your plan. Overreacting to small fluctuations can lead to unnecessary trades.

How can beginner investors avoid overtrading?

Beginners can avoid overtrading by following a plan that reduces unnecessary and impulsive trades. On the other hand, analyzing and recording each trade can help them learn from their mistakes. Setting stop-loss and take-profit levels may also reduce the number of positions you open. 

What is the relationship between overtrading and emotional trading?

Overtrading is often a result of trading psychology. The desire to recover losses quickly or fear of missing out (FOMO) can lead investors to trade excessively. These emotional responses often result in poor decision-making and unplanned trades. Emotional decisions usually lead investors away from logical analysis and strategies, which typically result in losses.

How can high trading costs from overtrading be reduced?

The best way to reduce high trading costs is to trade less frequently and make each trade more strategic. Every trade incurs some costs, so reducing the number of unnecessary trades can lower them.

How can day traders avoid overtrading?

Day traders can avoid overtrading by sticking to a specific strategy and plan. Setting clear goals and stop-loss levels for each trade reduces unnecessary trades. It is also important not to react to every small price movement and to avoid paying too much attention to market noise. 

How can I recover from the losses caused by overtrading?

To recover from the losses caused by overtrading, you must first stop the habit of overtrading and create a disciplined strategy. Carefully analyze market conditions and only trade when clear signals are present. Additionally, rather than rushing to recover your losses, remain patient and make rational decisions. Using stop-loss levels helps limit your risk.

Which indicators can help prevent overtrading?

Technical indicators like RSI, MACD, and moving averages can help identify overbought and oversold conditions in the market. Also, volume indicators may help measure the strength of trends, providing further protection against overtrading.