Overtrading is one of the most common ways a trader at any level—novice or experienced—can sabotage their performance. Yet traders don’t always recognize they are overtrading. Instead, they blame it on other factors, and worst still, try to fix it with more overtrading!
If I overtrade without knowing, the behavior can quickly turn into a negative spiral that destroys my account.
To address the issue of overtrading, I answer the following questions in this article:
- What is overtrading?
- How do we identify it?
- How do we fix it?
Let’s get started.
To make money in the markets, I must enter trades. If I don’t trade, I make zero dollars. So, I need a critical mass or a minimum number of trades to profit enough for my efforts to be worthwhile.
Overtrading happens when I trade beyond the conditions that made me successful. It’s hard to tell when I cross the line into overtrading because it’s a continuation of successful behaviour that I need to make money.
Let’s use food as an analogy: I need food to stay alive. However, if I overeat or eat the wrong types of food, I will degrade my health and even shorten my lifespan. Yet I can’t cut out food altogether because I need it to function.
Overtrading is similar. I must trade to make money in the markets, but I can reach a level where the behaviour becomes unhealthy.
What causes overtrading?
Ultimately, overtrading is caused by not having the discipline to follow a successful trading plan. There are several triggers, and while this is not an exhaustive list, here are some leading causes of overtrading I’ve observed:
- Assuming money should always be in the market. There will be quiet periods when a strategy does not produce any trades. It’s easy to feel that this is automatically bad because not being in the market means not making money. However, a critical part of trading is knowing when the conditions aren’t right and that it’s more profitable to stay on the sidelines in cash.
- Fear of Missing Out (FOMO). FOMO is a classic psychological issue in all areas of life, and I’d be surprised if there’s a human being on this planet that’s never experienced FOMO. So, it’s not surprising that traders feel FOMO in the markets. When the markets move, it’s tempting to want to be a part of the move, even if it means jumping impulsively in a way that does not fit the trading plan.
- Boredom. Sometimes, people just crave action. The boredom of waiting for a trade to line up is a real trigger to enter trades without the right conditions and eventually overtrading.
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There are lots of different ways to overtrade—let’s look at the most common:
- Chasing market moves. This is a symptom of Fear of Missing Out (FOMO). After a big price move, it’s tempting to jump into the market because of fear of missing out on more action. But FOMO-triggered trades ignore whether it’s a good entry. For example, the stop loss may be too far away, causing a terrible reward to risk ratio.
- Trading more volatile markets. Higher volatility is appealing because of the potential profits from larger price moves. After all, some volatility is essential to make money. But a market may not be more profitable just because it’s more volatile—it depends on trading skills and strategy. If I can’t profit from those markets, I should leave them alone. Otherwise, I am acting out of FOMO, and I’ll probably overtrade.
- Overly large trade sizes. This is a unique type of overtrading because it does not mean placing more trades. Instead, it means committing too much capital or risk to individual trades. This is a symptom of greed—imagining the profits if the trade wins. You should always consider the consequences of the size of the loss if the trade loses.
- Taking weak opportunities. With every strategy, some opportunities are stronger than others. Especially in discretionary trading (i.e., not systematic, or mechanical), it’s easy to fall into the trap of taking weak setups that don’t fully meet the trading plan criteria because of impatience or wanting more activity.
I wouldn’t be discussing overtrading if it did not impact performance, but what exactly is the impact of overtrading?
- Lower profitability. Overtrading results in trades of poorer quality, for example, with lower probabilities of hitting profit targets, or worse reward/risk ratios.
- More trades mean more costs. Every time I place a trade, I pay a spread or commission. A higher quantity of trades means higher trading costs. What’s the point of paying fees for bad trades?
- High trade sizes can kill an account. It’s common to hear about how one or two trades destroyed an account because the position sizes were too large. Risk control is at the heart of long-term trading success.
- Spending more time managing trades. Time is valuable and should be spent in areas that produce value. Overtrading commits time to a low-value activity.
- Not knowing what’s creating success. With excessive trading, I may not know which types of trades or markets produce success, which prevents me from improving.
The 80/20 rule
The Pareto principle states that roughly 80% of consequences come from 20% of causes (the “vital few”). The Pareto principle is also known as the 80/20 rule or the law of the vital few.
Applying the Pareto principle to trading means most profits come from a select few trades. The numbers may not precisely equate to an 80/20 split, but the general principle is what matters.
The Pareto principle can also apply to markets or strategies. For example, if I trade 5 or 6 markets, I might find 1 or 2 of those markets produce most of the profits. If I trade different chart patterns or strategies, I may discover that 20% of those strategies produce 80% of the results.
Overtrading works against the 80/20 rule
Overtrading takes us in the opposite direction to the Pareto principle—instead of focusing on the trades that give most of the profits, overtrading adds more trades to the mix, diluting performance.
There are steps anyone can use to minimize overtrading behaviour and improve performance.
Step 1: Have a written trading plan.
Overtrading means taking trades that are not part of a trading plan. To combat overtrading, the first step is to know when to trade by keeping a trading plan. A trading plan should include entry rules, exit rules, and risk control. The clearer the trading rules, the easier it is to follow them.
Step 2: Keep a trading record or journal.
Keeping accurate and detailed records helps identify which trades are profitable versus those that should be scrapped. It also tells me how often I take trades not part of the plan. Sometimes, just knowing that I must explain my actions in a journal prevents me from taking a trade that’s a weak setup or not part of the trading plan.
Step 3: Audit your trade records and journals.
Following on from Step 2, look for patterns in the results. Which types of trades are the most successful? Are specific markets not profitable? For day traders, are there days of the week or times of the day which are not profitable? There are lots of online trade journals that can help build and analyze this level of detail. My favourite online trading journal is “Edgewonk.”
Step 4: Reduce risk or stop trading when you overtrade.
If someone finds themselves routinely overtrading despite their best efforts, for example, by taking trades when bored or anxious, it is a good idea to reduce risk or demo trade until they are in a better routine. It’s crucial to protect hard-earned capital.
Step 5: Test new ideas before implementing them.
Of course, it’s okay to want to add more profitable trades. I can add new markets, strategies, or even lower timeframes. But I should test the ideas with a smaller risk per trade or on a demo account before putting on real trades with normal position sizes.
Overtrading can happen easily because it is born out of a good intention to place more trades to make more money. Yet the relationship between more trades (or larger position sizes) and profitability is not always positive. After a certain point, we experience the law of diminishing returns, where adding more trades means making marginally less money or even starting to lose money with more trades.
Overtrading happens for several reasons: chasing the market after a big price move, fear of missing out by not trading volatile conditions, or getting bored or anxious during quiet times.
To combat overtrading, the first step is to know when to trade by keeping a trading plan. Keep a journal to see how often you take trades outside of your trading plan.
Regularly audit your trading records. For example, a day trader may find trading on days with specific news announcements unprofitable, so they should scrap trading during those times.
Remember the Pareto principle, which states that roughly 80% of our consequences (or results) come from 20% of our causes (or actions). This principle suggests we can scrap many of our trades because they produce marginal or negative results.
It’s okay to want to add more trades by adding more markets or strategies to help make more money. Just be sure to test these ideas first before fully implementing them.
What is overtrading?
Overtrading means taking an excessive number or types of trades which do not add to profitability or performance.
What are the leading causes of overtrading?
Some leading causes include Fear of Missing Out (FOMO) after a big price move, chasing the market, or taking trades because of boredom.
Why is overtrading a problem?
Overtrading negatively impacts performance with poorly performing or unprofitable trades and increases trading costs through extra spreads and commissions.
How do you control overtrading?
Keep a trading journal to monitor trading activity. Periodically audit trade records to see if strategies, markets, or times of day do not make money and eliminate those trades. Test any new strategy or markets on demo accounts or smaller position sizes before implementing them fully.
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