Monday, October 06, 2014

why most traders lose money

Most traders have heard the statistics…”95% of traders lose money,” “Only 5% of traders can make a living at it,” or  “Only 1% of traders real make money.” Whatever the particular number is from recent studies, the fact is, many traders will lose money and it simply cannot be avoided.  All sorts of reasons are given for it, such as money management mis-haps, bad timing, bad government policy, poor regulation or a poor strategy. These are all well and good…and some of those do definitely play a role in individual trading success…but there is a deeper reason. A deeper reason as to why most traders will lose regardless of what methods they employ. I purport, that even if all traders knew how (keep in mind knowing, and doing are two very different things) to trade successfully based on current conditions, still most traders would lose over the long run.

When markets are understood, the idea that everyone can make money is not only inaccurate, but  impossible and laughable. Everyone making money means there is no market, because who would be taking the other side of the trade?

When all your friends are buying stocks and talking about oil going $200 (or whatever the number of the day is) and analysts are all over TV saying it is so, it is hard to take a contrarian view. After all, if you make a bet against everyone else and you are are wrong, your friends laugh at you because they are thinking their paper profits which continue to expand are going to be cashable at the bank soon. You experience regret for missing out on making some money and also may feel some social sheepishness. And heaven forbid you are right and people hate you because you just made money while they lost their shirt. Sound ridiculous?

It is very easy to say “I will follow the crowd and then know when to get out.” Actually doing it is something entirely different…which is why crowds move together.  This could largely be due to the human tendency to Extrapolate Trends. Trend extrapolation is the tendency to project current conditions into the futures, often assuming all else will remain equal.

What is really interesting is that while a hedge fund may make an average of 20%/year over the last 20 years, the average investor in that fund has a high propensity to make far less than that.  Why? Because they invest and pullout their funds at the wrong points, just as they do in the market

... Also consider this. In order for the glory stories to happen..such as traders making a 100%.. 500%…2000% returns (whether in one day, one year or several) how many traders must lose their shirt (or give up profits) for that to happen? Lots! Look at it a different way. That day trader that made $6,000,000 last year got that money from somewhere. Since small retail traders compose most of the total number of traders (high in number, small in worth compared to professionals) it was likely that $6,000,000 was taken right from those retail traders several thousand dollars at at a time. Someone lost money (giving it to this successful trader) or gave up profits (allowing the successful trader to profit). For a day trader to make $6,000,000 in a year, that means about 1200 people lost $50,000 each and/or gave up $50,000 each in potential profit!

In other words, the very thing which lures people in droves to the markets (big returns) ironically means that most of those people will be on the losing end of that exchange.

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