With less than 6% of all traders making money in the markets, it pays to study the common traits of those that fail as compared to those that succeed. Let’s get to work.
Why you will fail at trading – variance
Variance is the number one reason why beginner traders don’t make money.
Beginning traders must learn that their account values will fluctuate naturally when markets move against them. Emotional reactions to the inevitable and continuous waves of the ebb and flow of trading capital is exactly why most traders fail.
The very simple definition of variance is how far a set of random numbers can move away from average.
Let’s say we are flipping a coin that will land on heads 52% of the time. We can bet on an unlimited amount of flips, one flip per week. Can we make money betting on heads?
The answer is maybe. It depends on the wage size as compared to how much money we have. If we have $50,000 and we wager $50,000, then we have an exact 52% chance of making money. If we have $50,000 and we bet $0.10 on heads, the we have (practically) a 100% chance of making money (assuming no commission and slippage – and no inflation).
So how does variance cause traders to fail? It’s not actually because traders take too big of a position with each trade, but because when probability doesn’t go their way, they change their plan and do impulsive things. Let’s look into this example further.
Let’s bet $2500 on heads. We flip the coin each week. Let’s say we are unlucky and we lose $2500 for 3 weeks in a row. This is going to happen quite often, especially comparing the markets to coin flips. Now we don’t have $50,000 anymore, we have $42,500 (minus slippage and commissions, if we are trading the markets).
The emotions of trading and variance
Personalize this for a second. You take your “impossible to come by” trading capital, venture excitedly into he world of trading dreaming of total financial freedom and first class air transportation, and 3 LONG weeks into it you are WAY down.
This is more than most traders can take. We start questioning our strategy. We bet more in the next week figuring that the odds are that “things will turn around”. But they won’t turn around. The markets are more cruel than coins. Markets tend to continue on emotion-based trends.
So switch to tails (and bet more to play catch up)? Nope, wrong again. Just when everybody (like us) switches to tails, the market goes heads. That’s how markets move. That’s the basis and the nature of a trading market. If it seems like the markets are out to get you – that’s because they are – it’s how they work.
It would seem like common sense, when we see that we have a 52% chance to make money on coin flips, that we could pee on our boss’s desk and flip our way to riches. All we have to do is stick to our plan, right? But we change our plan. That’s EXACTLY what we (traders) do, especially when we are beginners.
The solution is to go into trading the the understanding that your account value will not always move in a favorable direction. You need to expect it. Your account will breath in and breath out with the market action as described above. You know this will happen. You observe this as it happens to you. You do NOT change your trading plan.
Why you will fail at trading – commission and slippage
Commissions and slippage have perhaps 1000 times more of an impact on our trading results we realize. I can’t emphasize this enough! Commissions and slippage (the amount between the bid and the ask) must be very much minimized to attain trading success. This is don by taking longer time frames on our positions and trading high-volume markets.
Let’s say we open a position that has a 54% chance of making a 2% gain, and a 46% chance of suffering a 2% loss.. Sounds like a great trade – I’ll take this all day!
On average, after a thousand trades like this, if we had $2000-sized trading positions, we can expect to make $40 per winning trade and we will lose $40 on each losing trade. After a thousand trades, the total profit of the winners would be $21,600 and the total losses of the losers would be $18,400. This is $3200 in total profit.
But what if we paid a $4.95 commission and the spread was $0.10?
The result would be a total loss of $26,700!
What! How is this possible?
1000 trades at $4.95 plus $10 from the slippage is $14,950. Remember that we have to take this hit going in and going out of each trade, so now we are up to $29,900. Subtract our “hardy” profit of $3200 and we see where that leaves us.
Also, we could have put our money in some sort of note to earn 4% per year with minimal risk, so we have to factor in that loss too.
Commissions and slippage make trading success nearly impossible
Trading is not a “zero sum” game. In fact, with commissions and/or slippage it’s nearly impossible to beat. The only solution is to pick a trading style that SIGNIFICANTLY reduces the effects of slippage and commission.
Trade in the very long term. Whatever chart time frame(s) you use to select and monitor your positions, go up two, or three, or four notches of time frame.
If you trade 60-minute charts, go up tot he weekly charts. It sounds drastic, but I’m dead serious. I don’t care if you like me and I don’t care if it sounds too tame or boring. If you want to win at trading, use weekly and monthly charts.
Also, pick high-volume markets to trade, and select trading strategies that might be one way as in buying and selling options. Watch out for complicated options strategies, however, as the slippage will totally murder you. I once heard credit spreads referred to as “alligator spreads” – because the slippage will eat you alive.
Why you will fail at trading – competition
Most beginning traders do not realize what they are up against. I’m not just talking about the market makers in their modern electronic pits, I’m talking about the high level program traders. There are, quite literally, floors and floors of offices filled with quantum physicists working full time to find exploitable inefficiencies in the markets. This is basically the same thing as what you are trying to do, but they do it 10,000 better.
They have algorithms that track the chance of traffic causing an executive being late for a meeting and how that might move the stock price. OK, maybe not really that, but you get the idea. These programs are considerably more sophisticated than anything you could possibly come up with to exploit or predict market movement.
What’s more daunting is that these program traders are so well financially backed, that their very presence causes the market to move in ways that will undermine your trading systems – intentionally. Remember – they are looking to exploit all market movement. They know where our stops are, from a mathematical sense. They know where we will give up and close our positions. They know where we will double down on a losing trade. They know when we can’t take it anymore and reverse our positions. They create fake moves at key inflection points like common moving average crossings.
We do this to ourselves too – the very nature of our simple systems, technical analysis interpretation, and stop placement causes them to work against you.
How can we alter our trading to be profitable in these conditions?
Trade in the longer term to minimize competition
The longer the term that we trade in, the less competitive the market movement will be and the more likely that our market’s true direction will move in the direction that we expect. By trading int he longer term, we stay completely under the radar of these well-funded and ridiculously-educated opponents. It’s boring, but I’m telling you how to succeed at trading, I’m not trying to entertain you. if you are looking to get rich quick, I wish you luck, but you are int he wrong place.
Why you will fail at trading – boredom and impatience
Even short-term traders are subject to the destructive feeling of needing to do something. Trading is sort of a hybrid between passive and earned income. When we earn money, we are conditioned to feel like we should be doing some sort of work. Successful traders have a few things in common, one of them is that they find something else to do as they stick to their plan.
If you are trying to get your trading profits on track, you should be looking to trade in much longer terms than as you currently trade. This tends to make beginner traders even more bored. Find something else to do – you do not always need to be executing orders to make money with trading. It’s just the opposite.
In the book, “The Way of the Turtle”, author and trader Curtis M. Faith and other traders were given algorithms to follow as sort of an experiment. Curtis excelled with his total returns while others lost money – with the SAME exact technical instructions.
He wrote that there was mostly one thing he did differently then the others around him. He didn’t trade trade when he wasn’t supposed to . I think he wrote that he ended up playing a lot of ping pong and getting away from his screens.
Interestingly and on a side note, he confessed that he would ask the under-performing traders how they were doing, knowing that they were trading when they were not supposed to. As if that helped keep his hands form clicking in orders of his own. He also indicated that he felt pretty bad about doing that to them even now, many years later. It’s a good read.
Other reasons why you will fail at trading
Trading addiction is real and it can wreck families and destroy wealth no slower than casino gambling addictions. Trading is extremely stimulating on every level – it’s also about money and power – which are among the biggest simulators in the universe.
These could range form being currently stressed out or angry about Something, to some sort of factor that happened long a go as in from childhood. I’m not judging, but whatever baggage that is in your closet will likely come rushing to the surface when you start making OR losing money at trading. If something is bothering you, sort it out before you start clicking in trading orders.
Lack of a simple and solid plan
After all we have discussed in this article, do you really think it’s prudent to shoot from the hip on this one? Yeah, good luck with that.
On the other hand, an overly complex system is not likely to hold up to any stress test either. You should be able to describe your trading plan to a child in a paragraph or so. You should have it written down in front of you in one page as you trade as a rule.
Remember our coin flipping example? You trading position size needs to be reasonable. Too big and you risk too much if the trade goes against you. Too small and the commissions, slippage, inflation, and the lost opportunity costs will take out out slowly but surely. Remember, you can just stick your money in an S&P index fund for 50 years and earn 8%. Trading income should only be measured on top of that.
One more thing about too big of a position size. This error is often why markets correct so sharply. Many traders, even the big ones, become over-leveraged. As the markets crash violently against them every decade or so, the margin calls force everyone to sell their positions for minimal value. Just when no one has any money left, the correction subsides. Do be in this crowd! Be the one with some money left over to make extreme profits on the rebound.
Sometimes traders are pushed to devastation by their personal money needs. Again, I don’t judge here – the struggle is real. If you want to trade, fine, but don’t quit your day job. If you were laid off or forced to retire, etc, then find something else to do for money and trade on the side.
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