Why Most Traders Fail – Part 1
posted on October 8th, 2010 by David
Anyone who starts down the road to becoming a trader eventually comes across the statistic that 90% of traders don’t make money. The data shows that over time 80 per cent lose, 10 per cent break even and only 10 per cent actually make money on a consistent basis.
Although most people who start to trade may be profitable for a short time, all too often they are no longer trading after two or three years. The interesting thing about this statistic is that it is not based on geographical region, age, gender or intelligence. All aspiring traders want to be in the 10 per cent that consistently make money, but so few are willing to put in the time and effort to achieve this feat.
When I present to people that want to learn how to trade I ask them whether they would like me to teach what the 10 per cent of traders know or the other 90 per cent, and every time they say they want to know what the successful traders know. To me the answer is simple. All one needs to do is look at many of the books and courses available and don’t do most of it. To be successful you need to do what the majority of traders don’t do.
So how does an inexperienced person work out from the overwhelming load of information out there what they should be doing to become a successful trader? After all, you don’t know what you don’t know. But you can learn from those who do. In this article I will explore why most traders fail and more importantly what to do about it so not only will you not become another statistic, but you will also understand what the successful 10 per cent of traders do.
How do you become successful trader? The equation is really quite simple:
Knowledge + Experience + Effort = Success
I have never found a consistently profitable full time trader who told me that they got there through luck. All followed these three simple rules or steps:
Step 1. Acquire the knowledge
Step 2. Gain experience in the market
Step 3. Make an Effort: The above two steps are of no use, unless the trader is willing to put in the required work effort.
Another statistic is that learning to trade is a two to five year experience. I can honestly say that there is no substitute for effort and there are no short cuts to becoming a professional and competent trader. Like it or not, learning to trade really is a two to five year experience.
In reality, self-education requires both commitment and work. However, what I have discovered is that you don’t have to be a genius or a rocket scientist to achieve consistently profitable returns in the share market. In fact, I think it helps to not be a rocket scientist. If this is correct then why do most traders fail?
What I have discovered is that many newcomers to the market tend to complicate the process in attempting to profit from the share market. I attribute this to two things. Firstly, the experts in the financial services industry often make investing in the share market for the small investor seem complex, mysterious and only for those who are wise and highly educated.
Secondly, it is the marketing companies (read: many share market educators) who promote that they have all the answers to gaining riches in the share market. They do this with statements like “No knowledge, No experience and No time. No Problem, we will help you get rich quickly.” In reality all they do is fill their own pockets from expensive seminars or DVD sets.
This brings us to the single biggest reason why most traders fail, and that is, a lack of knowledge. Often those who realise they need an education look in the wrong places and therefore pay for poor quality. At the end they still don’t know how to trade.
Many individuals refer to themselves as traders simply because they buy and sell shares. However, when questioned on how they analysed the stocks they were buying and selling, many claimed they read reports in newspapers and on websites, and occasionally looked at online charts with their broker. Upon questioning them further I found that while many had a rough idea of the fundamental information needed to assess a share, they had little or no idea what they were looking at when it came to understanding how to interpret a chart, and none had a plan or understood anything about money management.
An educated trader, however, understands the importance of a trading plan, how to analyse a share in order to know why they are buying and selling, and how they will manage the trade. Most importantly, they also implement strong money management rules such as ‘stop loss’ and ‘position sizing’ to ensure they minimise risk and maximise profits. More recently, I have seen traders and investors begin to place more emphasis on charting techniques in an attempt to make better informed decisions about their investments. Although they are on the right track, in my experience they generally do not understand how to correctly interpret a chart and this only compounds the problem.
The 90% of traders who fail are made up of three groups. The first are those who are blissfully ignorant to the fact that they actually need an education. Those who know they need an education but do not want to commit the resources of time and money into obtaining the right education. Lastly those who overestimate what they know, and therefore mistaken believe they already possess the education. From experience this last group is the largest and most dangerous of the three, and I will go as far to say that the majority of people reading this article would fit into this category.
Trading the share market inherently involves some level of risk. Yet the majority of people attracted to the market are willing to take higher risks – believing they are adequately equipped to trade after reading just a few books or attending a weekend course. These people are generally in the third category above. Indeed, many traders seek instant gratification, plunging head first into the market while attempting to apply complex strategies in the hope of profiting from their efforts. Sadly, many lose their hard-earned savings due to unrealistic expectations.
We are told that knowledge is everything, however, in the context of trading I believe it is the application of the correct knowledge that is everything. The streets are littered with ‘would be traders’ and in a bull market many are profitable mainly through sheer luck rather than from the application of a solid plan. Strong bull markets tend to hide mistakes in judgment and lack of knowledge, which is why I say that unless you have been trading successfully for more than two years, you cannot consider yourself a trader. Notice I did not say trading for two years, but rather trading successfully for two years, as there is a real difference between the two.
Every week I am approached by individuals that want me to teach them to trade, and the majority want it to be quick, easy and cheap. If that sounds like you, then probability suggests that you are part of the 90 per cent I mentioned above and a part of the second category above. Let’s get real! Would you go to a doctor that has watched some video’s or attended a weekend workshop? Would you get your car serviced by someone who has done the same? Would you allow your children to get on a bus where the driver has only read a book on how to drive? My guess is that you answered no to these questions.
It is accepted that it takes three to four years to get a University degree to give someone the qualifications to get into their preferred profession. Trading needs to be given the same sort of respect and must be treated like a business, requiring you to combine a high level of knowledge with experience to increase your probability of success over the longer term. Heading this advice will make a huge difference to your trading journey as ignoring this is the biggest reason why most traders fail.
Irrespective of why you trade, I have found one thing to be true – that learning to trade is the easy part. The hard part is in understanding your psychology, because it’s true that the nine inches between your ears will determine your success as a trader. If knowledge is the main reason why most traders fail, then psychology is the second major reason. A trader’s attitude or psychology determines not only how they approach the three steps above, it also determines how they will approach their trading.
After having worked with aspiring traders for over a decade, the emotions of fear and greed drive traders and investors alike and without the correct education these emotions are often amplified, which again leads to costly mistakes. To highlight this, we receive many calls from individuals with no knowledge or experience wanting to learn how to trade CFDs. When I ask them why they often tell me it is because they do not have much money. However, I would suggest that this is the exact reason why they should not be trading CFDs. Let me explain…
The thinking of people who tell me that they have very little money generally stems from greed. They believe that if they have $2,000 to invest and the share they invest in rises by 20 per cent, then they will only make $400, whereas, if trading a CFD leveraged at ratio of 10 to 1 they will make $4,000. Therefore, in their mind the desire for quick returns by trading a CFD is worth the risk, although in saying that they rarely if ever think about what they can lose.
Herein lays a challenge if you do not have much money, you cannot afford to lose it and you will be more emotionally attached to it. Therefore if the trade goes the wrong way even a little bit, the fear of losing kicks in strongly, resulting in an exit and a loss. Many novice CFD traders further compound their mistakes by exiting profitable trades too early for fear of losing their profit. This can occur with all leveraged trading such as currencies, commodities, options.
Fear is your biggest enemy as a trader as it is a much stronger emotion than greed, and a trader’s fear stems not only from a lack of knowledge or confidence in their trading plan, but also in the trader’s confidence or belief in their ability to enact the plan successfully. The answer to solving this issue is to simply follow the three rules above. Fear only kicks in once a trade is placed, what leads us to this point is greed or the desire for quick easy returns.
This desire for quick returns on the share market reminds me of a well-known children’s tale from Aesop’s Fable – the story of the tortoise and the hare. In this book the hare is impatient, cocky and willing to take unnecessary risks to win the race. The tortoise, on the other hand, is happy to plod along at a steady and consistent pace. Who wins? Unfortunately, I have met thousands of traders that adopt the ‘hare’ approach to trading. When I ask what returns they are getting on an annual basis, more than 98 per cent claim they get less than 10 per cent. So what is the moral of the story? ‘Slow and steady wins the race!’ In my experience those who trade less over longer periods of time make far more money than those who do the opposite.
The irony is that most people seek out quick fixes to achieving their financial goals with the mindset that short term gratification will fulfil their long term needs. As mentioned above, this is often spurred on by the proliferation of seminars and information available. However, what I discovered along my trading journey, and I still apply it today, is to keep things simple and to consistently revisit the basic foundations of trading.
To finish off this first part of my article, I want to share with you some information that you only get if you work in the industry. Recently I was talking to a couple of software/data providers, and over the years have regularly talked with Brokers, CFD and other product providers. The overwhelming fact they report to me is that they experience a large client churn, or clients opening and closing accounts, because of the two areas I mention above.
When they have researched their clients they report that the majority of people who have closed their accounts are doing so because they have lost money, or in other words they have become part of the 90 per cent. It is not uncommon for them to share with me that the majority of their clients closed accounts in less than 9 months. Would it surprise you that the majority of these people are men! I am beginning to think unlike what Skyhooks sang, that ego is a dirty word, or at least in trading it is, and men seem to have too much of it.
It is a statistical fact that many of you who are reading this article will not heed the words on this page, believing you will not fall prey to the pitfalls that I have mentioned. Why? It stems from overconfidence and ego.
In my next article I will explore a number of issues relating to why most traders fail, including overconfidence and ego. I will also discuss under confidence and why this is also damaging to your trading. Other areas I want to discuss are over trading, trading short term, poor money management, more on the fear factor and two of the biggest challenges for most traders – setting stop losses and knowing when to sell.
Dale Gillham – Wealth Within