What is Overtrading & Why Traders Do It?

Overtrading refers to the excessive selling and buying of securities in financial markets, driven mainly by emotions and impulses rather than any defined strategy or plan. It may lead to severe consequences like higher transaction costs and losses. To further define overtrading, it can be called an unnaturally high volume of trading within a small duration, often without any proper rationale/basis behind the same. 

But why do traders indulge in it? Some reasons may include the following: 

• Driven by emotions such as anxiety, excitement, greed, fear, and even FOMO or the fear of missing out 
• Some may do it to earn profits quickly without proper stock analysis 
• Many traders don’t have well-structured trading plans, leading them to make impulsive decisions 
• Overconfidence in one’s abilities may be another reason, along with impulsive reactions to market volatility or short-term fluctuations. 
• Lack of proper risk management strategies may lead traders to keep entering or exiting positions in search of profits

In his pioneering book The Psychology of Trading, Dr. Brett Steenbarger likened it to daydreaming, indicating that traders wish to feel in control and powerful. However, the markets are hard to predict likewise. 

Signs You Are Overtrading

Now that you know what overtrading means at a basic level, here are a few signs that could indicate that you are overtrading - 

• Trading more frequently than what you usually do or planned for 
• Not following any clear trading strategy or basis for executing trades
• You are constantly attempting to recover your losses by making more impulsive trades
• You are always looking at market reports and charts while constantly looking out for opportunities, even when you should ideally avoid trading 
• You hold excessive opening positions in comparison to what your capital can manage comfortably, thereby scaling up overall risks 
• Betting a disproportionate or huge amount for a single trade or deviating from the predefined trading plan and risk management blueprint 
• Feeling anxious and stressed about trading,while experiencing a lack of control or trying to prove yourself even when you’re failing constantly 
• You’re attracted to the thrill and excitement of trading or are being excessively pessimistic/optimistic about any particular stock 

Psychological & Financial Consequences of Overtrading

There are several psychological and financial consequences of overtrading. These include - 

Higher transaction costs

Trading excessively or too frequently may lead to higher transaction costs and other charges which may deplete profits

Excessive risks

These may arise from overtrading, particularly if you enter a large number of trades without a strategy or risk a large proportion of capital on one or a few transactions 

Poor performance

It may also impact the overall performance of your investments since you could miss out on potential gains in the long term 

Higher anxiety and stress

You may experience constant pressure to make profits or prove yourself, along with feelings of stress and anxiety, which may impact your mental wellbeing considerably 

Trading account damage

You could end up damaging your trading account balance if you incur higher losses in comparison to the profits 

How to Avoid Overtrading 

Here are a few ways you could consider to avoid overtrading - 

Create a proper trading plan 

You can start with a predefined trading plan based on your capital, risk appetite, particular entry or exit criteria, realistic targets, risk limits, etc. This should be your guide when trading and nothing else. 

Prepare a checklist

Prepare a checklist for yourself before each and every transaction. This can ensure that you are following your trading plan diligently. The checklist can include confirmation of entry and exit points, risk management parameters (stop-loss, position size, etc.), trade limits for the week or day, verification of market conditions, etc. 

Set trading limits

Set a maximum limit for trade frequency or the maximum capital you wish to invest/risk each week and day. You can consider stopping trading once you reach these limits, even if you see any possible opportunities available in the market. 

Make a trading journal

You can create your own trading journal with the details of all your trades, reasons for entering/exiting, profits/losses, plan deviations, etc. Reviewing this regularly will help you identify signs of overtrading or emotional decision-making, helping you swiftly address the same. 

Have a cooldown period

After any profit or loss, ensure that you have a cooldown period where you step back and take a break from trading to give yourself some rest. This can help you clear your mind before you start trading again. 

Set trading time periods

Have a set time limit fixed for trading activity each day and once you have crossed it, you can consider stopping trading to avoid impulsive decisions.

Real-World Examples of Overtrading Mistakes

There are several real-world examples of overtrading where investors or traders end up losing due to impulsive decisions. 

For instance, JP Morgan Chase lost more than over $6 billion in 2012. This was the outcome of the London Whale trading scandal, and although there were several aspects to the same, one of them was overtrading. A small team kept making increasingly bigger and more frequent trades that deviated from the bank’s risk management blueprint, eventually contributing to the huge loss. 

Another example is quite common in the stock markets when brokers are under pressure to sell newly issued securities that any firm’s investment banking division has underwritten. They get bonuses of a certain amount if they can secure a specific allotment of any security from customers. These may lead them to encourage overtrading in a short span of time without always having the customer’s best interests at heart. 

Concluding Notes

While overtrading could seem like a proactive way to capitalise on every market movement, it could do more harm than good, as it could be a result of a lack of planning and impulsive decision-making. This can not just damage your portfolio, but also your long-term financial objectives and mental health. 

Realising that you are overtrading is the step to avoid such a scenario. You can implement a few disciplined measures to ensure you are trading with a clear mind, well-defined strategies and risk appetite.

At the end of the day, successful trading is more about making the right trades rather than the number of trades.