A good definition of overtrading is ‘taking a position which is too large in relation to the available trading capital’.
What is overtrading?
Overtrading is a seriously bad practice and must be avoided by commodity traders at all times.
Your trading capital has to cover any losses you may make, allowing for the fact that your trading results are likely to produce strings of losses, followed by shorter strings of gains. The losses will outnumber the gains but should be significantly smaller – if you are cutting your losers and running your winners.
While it is open, every trade is committing some of your capital, which is required to cover its potential losing outcome. It is only your uncommitted capital that can support the opening of additional trades and so this amount must be known whenever a new trade is considered.
The uncommitted capital must not be exceeded by the loss potential of an additional trade, otherwise you will be overtrading.
The amount staked by professional traders on a single position is usually much less than you would think and depends on the particular trading rules chosen.
A major reason for these small stakes is because in addition to providing cover for all potential losses on open positions, a large proportion of the capital must be safeguarded to ensure that the system can recover from inevitable setbacks.
Capital must not be allowed to fall below a level which will enable full recovery to be made within a reasonable time span following a bad spell of trading. The way this all operates is dictated by several factors, one of which is the drawdown characteristics of the system you have chosen to trade.
The thorough testing process to which professional traders subject their systems enables them to assess what is known as the risk resonance of their system, which is then used in deciding the amounts to be staked. This is not a complex operation for traders to conduct because it is all built into their methods and software.
In developing their best practices, systems traders have devoted a great deal of study to this aspect of trading because overtrading has such seriously damaging effects on results.
Copyright David Bromley 2006
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