Traders, Here's What You're Doing Wrong (And How To Fix It)
Benzinga recently had the chance to speak with TD Ameritrade Chief Strategist JJ Kinahan about common mistakes he has seen from inexperienced retail investors.
Kinahan offered his insight on a couple of common mistakes and provided some useful advice to traders.
1. Trading Too Big
Kinahan began by addressing the tendency for new traders to want to go “all-in” as a common misstep among inexperienced retail investors.
“I work for a brokerage firm, so I’m happy that people trade more, but they trade too big. When an all-in situation goes against them, they immediately stop themselves out,” Kinahan explained.
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Instead of taking a full position all at once, he recommends accumulating a full position via several smaller trades over time. “The new trader tends to think of everything as an all-or-none game, whereas professionals are very iterative about getting in and out of positions.”
2. Improper Diversification
While many traders are aware of the risk reduction that diversification can provide, Kinahan still sees new traders who ignore the “don’t put all your eggs in one basket” investment adage because they are convinced in the strength of one or two stocks.
However, Kinahan also told Benzinga that he sees a much more common mistake when it comes to diversification.
“A bigger mistake diversification-wise is that people forget that many investments are correlated. They think, ‘Oh, I’m going to buy the NASDAQ and I’m going to buy the S&P 500.’ Well guess what? If one of them is going down, the other one’s probably going down too.”
Kinahan referred to this phenomenon as the “myth of diversification,” meaning that portfolios comprised of many different stocks can still be poorly diversified if the correlation among the stocks is high.
Diversification Advice For New Investors
When Benzinga asked what advice Kinahan would give to new traders, he focused on risk management.
As an example, he explained that Exxon Mobil Corporation (NYSE: XOM) and Delta Air Lines, Inc. (NYSE: DAL) (an oil company and an airline) might seem like a diversified pairing to an inexperienced trader, but that both stocks actually have a large exposure to crude oil. Instead, a consumer staple stock, such as Johnson & Johnson (NYSE: JNJ), would make a much better pairing with Exxon from a diversification standpoint because the two companies have little common operational risk.
“When you think about diversification, you should always be thinking about risk exposure,” Kinahan concluded.
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