When traders start making several transactions that lead to poor investment outcomes at higher costs, it is called overtrading. Generally, traders do this when they want to increase profits or want to recover from losses as quickly as possible without taking time to understand the market. Impulsive repeated trades can cause a spike in costs and are subject to higher market risks.
Key Takeaways
- Impulsive buying and selling of excessive stocks is called overtrading.
- Overtrading is a bad trading practice that is not backed by a well-researched trading strategy and is different from active trading.
- Overtrading is caused by emotional trading decisions, trying to recover from past losses quickly or FOMO.
- Overtrading can cause losses, negatively impact the market and increase additional costs in trading.
What Is Overtrading?
Overtrading refers to the process of excessive buying or selling of financial securities in an unplanned, impulse-driven way rather than following a well-researched financial strategy.
While there is no fixed threshold of trades, crossing which might qualify as overtrading, if a trader is influenced into buying or selling stocks in excess by emotional aspects rather than a sound trading strategy, then it qualifies as overtrading.
Overtrading is often characterised by repeatedly entering and exiting trades because of a fluctuating market instead of properly studying the market trends. Wanting to replicate an older profit or recover from a loss quickly also might lead to overtrading.
Causes of Overtrading
There can be many causes for overtrading; the most significant of them are as follows:
- Emotional Trading: Traders are often influenced by emotion into acting impulsively owing to fear, greed or excitement.
- FOMO: Traders often fear missing out on profitable trading opportunities without studying the current market scenario, leading to overtrading.
- Revenge Trading: Often after facing a loss, traders attempt to quickly recover that loss by taking riskier steps in trading than they would have avoided, usually in normal circumstances.
- Lack of Strategy: Traders who do not have a fully fleshed-out market strategy can overindulge in trading assets, leading to overtrading.
- Market Excitement: Traders who join the market bandwagon out of peer pressure might overtrade.
- Unrealistic Return Expectations: Traders trying to replicate past profits quickly by overbuying stocks can overtrade as well.
Also Read About:Understanding the Past, Present and Future of Trading
Signs of Overtrading
Overtrading has multiple warning signs, like:
- Increasing Trade Frequency: There can be a noticeable increase in trading frequency,which indicates overtrading.
- Repeated Losses: If a trader suffers multiple losses in a very limited time span, it might be a sign of overtrading.
- Impulsive Decisions: When someone is overtrading, they often don’t have any clear trading strategy or plan for executing trades. As a result, they impulsively decide to buy or sell assets.
- Ignoring the Trading Plan: A trader can start making impulsive trades, abandoning any previous trading strategy, a sign of overtrading.
Also Read About: Types of Trading in the Stock Market
Effects of Overtrading
Overtrading has consequences on both finances and market behaviour. Each transaction made by a trader involves brokerage, transaction levies, and taxes, including short-term capital gains (STCG) tax triggered on profitable short-term holdings. Frequent turnover eliminates the benefit of holding assets for lower long-term tax rates, while compounding trading costs and taxes that eat directly into net returns.
Repeated trading makes it difficult to follow and to stick to a fixed trading pattern. Impulsive trading habits like overtrading can also cause frequent losses, which add up to the emotional stress of a trader who is already trying to recover from a loss.
It is, therefore, always advisable to follow a fixed trading pattern and not give in to impulsive trading urges prompted by external causes.
Overtrading Example
Consider a trader who has made five planned trades and profited ₹500 from each trade, making a gross profit of ₹2,500. However, this initial success prompts the trader to impulsively execute ten additional, unplanned trades outside their original strategy.
Assuming these 10 extra trades yield a modest gross gain of ₹1,000, here is how transaction costs and taxes erode the overall returns:
- Gross Profit: ₹2,500 (planned trades) + ₹1,000 (impulsive trades) = ₹3,500
- Brokerage & Transaction Charges: ₹40 per round-trip trade across 15 trades = ₹600
- Statutory Levies (STT, GST, Stamp Duty, Exchange Fees): Approx. ₹50 per trade = ₹750
- Short-Term Capital Gains (STCG) Tax: 20% on realized short-term gains (20% of ₹3,500 gross gain) = ₹700
Net Profit Breakdown
Net Profit = Gross Profit - (Brokerage + Levies + STCG Tax)
= ₹3500 - (₹600 + ₹750 + ₹700)
= ₹3500 - ₹2050 ₹1450
While the trader generated ₹3,500 in total gross gains, ₹2,050 (over 58% of the total profit) was wiped out by combined transaction fees and STCG tax liabilities.
If those 10 impulsive trades had instead broken even or yielded a minor gross loss of ₹500, the fixed transaction costs (₹600) and statutory charges (₹750) would have completely surpassed the remaining gross profit, turning what was a clean ₹2,500 gain into a net loss.
Also Read About: What is Equity Trading?
How to Avoid Overtrading?
If you start adopting proper trading habits, you can prevent overtrading. Some of these habits are:
- Setting a trading plan: Since trading involves analysing the market, it is best to set a proper, well-researched trading plan. You should stick to the plan and not make impulsive decisions that can lead to overtrading.
- Defining trade limits: Set a daily or weekly trading limit and make sure to follow it so that you can consciously stop trading beyond your self-imposed limit.
- Using stop-losses: Stop-loss orders are useful risk-management tools that can be used to reduce overtrading.
- Maintaining a trading journal: By keeping a trading journal, you can notice if you are giving in to impulsive or emotional trading patterns. Stop before overtrading patterns take over.
- Taking breaks: Take breaks after significant losses and study the market and research trading patterns. Develop a new strategy before jumping back in to try and recover the losses immediately.
Also Read About: Turtle Trading
Overtrading vs Active Trading
Overtrading is not the same as active trading; while the former is a bad investment habit, the latter is a well-planned and tested strategy. The differences between them are:
| Overtrading | Active Trading |
| Frequent, unnecessary trades without any fixed strategy. | Frequent buying and selling of trades based on a deliberate strategy. |
| Influenced by emotions and can be extremely risky. | Are well-planned with defined objectives and risk controls in place. |
Conclusion
Overtrading often looks attractive in the face of emotional decision-making, but it can be a risky move while trading. Traders often make frequent unnecessary trades to recover from past losses or out of the fear of missing out on profitable trades. Overtrading can cause losses, increase additional trading costs or negatively affect the market. It is important to understand the market and make well-researched and disciplined investment decisions.
Looking to invest?Open a Demat Account with Angel One and start trading seamlessly.
