Why do so many Traders Lose Money?

Q. Why do so many traders fail in this business?

A: It is a fact that most traders lose money with foreign exchange trading being the biggest culprit followed by futures, options, contracts for difference/spread betting and trading shares on margin.

I feel that there are many reasons why people fail in this business and, as in most walks of life, there is no 'one fits all' answer and because of this certain people may fail for one single reason or perhaps, more commonly, a combination of reasons which statistically combined leads to the increase in the probabilities of 'risk of ruin'. Generally these reasons might be -:

  1. No edge, no idea what they're doing with anything. Can't beat commissions.
  2. Failure to learn to control emotion when faced with losses, gains, luck and indecision, which leads to poor decision making. Remember trading is 10% learning about the market and 90% learning about you. Unfortunately, if a trader does not know himself, the markets are an expensive place to find out. It is not easy to be unemotional when trading as that's how we're all wired. The key to stop people from exploiting your emotions is to change but first you need to identify the common behaviour patterns that lose you money -:
    • Emotional bias - this is when you ignore the bad news and focus only on the good news.
    • Expectation bias - tendency to believe in things that you expect. As an investor your job is to research and analyse all possible outcomes (including those you expect or hope for or fear) from an unbiased perspective; in other words you should just care about facts just facts and investigate thoroughly.
    • The disposition effect - this is a classic; cutting your profits and letting your losses run - quite the opposite of what you should be doing.
    • Loss aversion - it is scientifically proven that losses affect traders more than gains which means that you become more emotional when losses are incurred which increases the risk of an irrational decision.
    • The sunk cost fallacy - taking into account existing losses already incurred in a holding to influence your action; in other words the bigger the size of a loss incurred in a trade the more likely you are to hold onto a losing trade as opposed to cutting the loss and moving on to a more profitable trade.
    • The bandwagon effect - the tendency to believe in following the crowd; thinking something is good because everyone is doing it which thought process is sure to get you in at the top and out at the bottom.
    • Past price fixation - letting past prices which no longer exist influence your trade, 'I will sell it if it gets back to £2.'
  3. Failure to understand fundamental and simple mathematics which they are battling against if too larger percentage of one's trading pot is risked on individual trades.
  4. Failure to recognise and then fully understand that trading, especially short term, is about probabilities and NOT PREDICTIONS.
  5. Failure to stick to one system. Most traders typically take a few losses and then they start trying to change things, tweeking things, and then try finding something else. They think they can find a no-fail trading system that has at least a 99.9% strike rate! However, in real life it is not the system which determines the strike rate but the person using the system and their judgement when applying the system that will determine the strike rate. You can take 100 traders and teach them all one identical system, give them the entry rules, the stop loss rules, the exit rules and show them how to read the charts; you could even tell them to trade a selection of stocks, forex pairs or whatever - but I can tell you now that all of the 100 traders would have different results, why? and how do I know this? Well the first answer is simple, it is not the system that gives the different results, the trading system will give the same entry points, stops, targets over and over again on everyone's chart, nothing changes, what the system flags on one trader's chart, it will flag the same on trader99's chart! It's the trader using it that determines the results and makes different judgments. Do you have the discipline to pull the trigger and follow the system? Do you have faith in what you are doing? Do you find yourself second guessing your decisions? Do you find yourself taking losses too deeply? Do you find yourself jumping from system to system after a couple of losses on one system?
  6. Entering the market place with preconceived ideas about trading which are not only false but destructive. For example someone might say that 'If I have a better computer with four screens and a lightning fast internet connection then I will be a better trader'.
  7. Timing. Market timing is the most important expertise you must master to become a successful trader. This is where the majority of traders fall by the wayside. Buy too early and you are squeezed out on any temporary falls. Sell short too early and you are squeezed out on any up moves, even if after a few days your analysis is proved correct. Study your own trading weaknesses then form a plan to combat them. Perhaps one of your weaknesses is to have no plan ready in the first place. I recommend writing down your plan before you trade, as once on paper you are more likely to adhere to it.
  8. Under capitalisation and/or external money pressure which leads a trader into a position where they feel that the market must produce 'regular' and 'consistent' profits for them. This causes emotional strain when the market doesn't fulfil our inherent emotional demands ie regular income.

If you don't understand markets, if you don't systematically prepare for trading, and if you haven't sufficiently rehearsed trading-related skills, you'll perform miserably and you'll become emotional.

Likewise, to make money at spread betting you MUST invest time and energy. You must learn how to control your emotions (both fear and greed...this is the really difficult one and after doing this for a long time I still sometimes let them get the better of me, almost invariably to my cost). I've made a tidy net profit spread betting, but it hasn't come easy, and there have been some costly lessons on the way. Nothing like losing 7 grand in a day to teach you a lesson. (nothing like making 30 grand in a day either...but that is another story).

Emotions in play: 'Bit of a roller-coaster ride this week. On Monday evening - when I checked the portfolio - I wanted to throw the computer out the window and kick the cat. This evening - with a nice blue board - I'm hugging the computer and the cat gets fish for tea. Will the markets please make their mind up, one way or another. KGF short closed on significantly tightened stop yesterday - just off my target so happy.'

Q. What makes a successful trader?

A: Successful traders have a disciplined and systematic approach to trading - this is the only way that you can guarantee consistent profitability with minimal risk. There is no doubt that there are traders who take huge risks but these traders seldom make consistent profits in the long run. Remember you can trade responsibly and in a very disciplined manner and still find it highly rewarding.

Successful traders always have the following attributes -
  1. They know what they want and why they want it
  2. They have a clearly defined set of goals and trading plan
  3. They have a successful trading strategy and they stick to it
  4. They trade size every trade they place

I cannot stress this sufficiently - at some point just stop and write a plan. A trading plan. Something that says this is the trading me, this is how I'm going to find trades, this is what I will look for before my trade, during and after my trade. The plan should include entry points as well as exit strategies - including the setting of stops.

And make sure you keep records. Do you have more success with MACD or Point and Figure Charts. Do you trade better when you have 8 patients and a root canal or when you have 3 patients and a crown. Seriously. The most successful traders I have met do this. It doesn't matter whether you get the ideas for you plan from other people, although I would just caution you only to pay more attention to people who you can prove to your satisfaction are making money from their trading. The point is that you start to treat your trading as you would any business.

Q. Do you need to have a special talent to be good at trading?

A: Well, ignoring the talent, you need a special psychological profile. The willingness to take and accept risks, as well as to mentally being able to deal properly with statistics and the draw down period that will inevitably come at some point. Not from the money management side, but one needs to be sure enough to trade, even when you have some bad days.

Successful traders take personal responsibility for their performance, they are accountable and don't blame someone else for their losses on their trades. Also, a quality I've noticed in a lot of successful traders is an immense humility. These are people who have complete control over their ego. They are responsible and happy to admit they were wrong, happy to admit they need to learn more, happy to admit they have limitations. The three most important words you can ever say are: 'I Am Responsible'.

It is not difficult to learn the mechanics of trading but to become consistently successful, time, experience, and to a certain extent knowledge have to come into play. Becoming a master at anything (including trading) requires a number of years of training, which can be formal or not.

I've been on this side of the market for 15 years. The people who open trading accounts not minding that they lose their first fist block of cash will always lose their money. It is the mindset that is completely wrong from the outset.

Q. What type of people make the best trader?

A: I played lead guitar for a number of years and I believe there are some striking similarities in the discipline required to learn to trade and learn to play an instrument.

In order to be a good musician you have to practice - in my case, even after I could play well I still practiced a minimum of 4 hours a day and maximum of 10-12 hours a day, which is roughly the amount of time I am now spending in front of a screen. Coupled to that, when you decide to learn an instrument you have:

a) No idea if you'll like it
b) No idea if you'll be any good
c) No idea if there's any point, save for personal gratification

The only way you'll get any better is to practice and even though you'll end up loving your instrument, you'll spend a lot of time hating it, wishing you'd never taken it up etc...

Sounds familiar? It certainly does to me!!

The key to becoming good at a musical instrument is determination to overcome some massive barriers that music throws up along the way - not that much different to my experiences of trading so far!

Someone else has likened the timing of good comedians to the timing needed to trade...it's no good being right at the wrong time.

Comedians also take risks every time they go out on stage, and they learn their craft by 'dying' a few times, or a few hundred times, which is also what newbie traders have to do. It is the ones who can survive this who go on to be winners, although I am sure that comedians, like traders, can sometimes do exactly the right thing, but still the audience (the trade) goes against them. That's show business.

I think good poker players would also make good traders; in fact I'd say that the best investors may also be the best poker players. Trading success is mostly psychological. I suggest that the 'trading mind' can be summed up in the words 'patient aggressivity'. You need to be able to sit there and monitor the market, depending on your time frame, for hours, days, or weeks at a time, then, when it's time, jump in. Then, you also have to maintain the same composure whether betting $1, $100, or $1,000,000.

You also have to stick with your system, believing in it, even after 2,3, or 4 hopefully small losses, still ready as ever to take the next signal, because that is likely the one that will make you whole again, and possibly make you rich. On a more practical level, you probably have to be willing to sit in front of a computer for hours at a time, basically bored - until the signal forms, then you are suddenly under unbearable tension, either to cut your loss short, or be willing to hold onto a profit hoping for an even bigger profit.

In my opinon poker has more skill involved than horse racing. With poker you have greater control over the outcome. As in trading, in poker there are always better players than you. Players who are good enough to stay at the £1000 buy-in level, which is high, are very good players. However, players who are good enough to regularly play the £5000 buy-ins are better players than them. It's a hierarchy and like in everything in life, you only become better by going up against better opponents and sometimes losing your money. Hopefully you'll get it back later when you improve. Almost all players exercise bankroll management and stop losses therein. Money management is as key there as in the stock market.

I happened to see an interview of poker superstar Howard Lederer in which he discusses poker and its relation to trading. He spends the majority of the video talking about bet size and money management. He specifically states that he loses more hands than he wins and yet he still makes money. This is often the case in trading where the best traders lose more often than they win but their winners are much larger than their losers. Howard also mentions that those who play less frequent poker hands tend to win the most money. In my opinion what he's really saying is that those who have and follow a 'STRATEGY' with 'DISCIPLINE' make the most money. I stress both discipline and strategy because without both a trader might as be lost in the desert without water because their chances of survival are slim to none. Lederer also makes mention of folding and how that preserves capital and is a very important part of any successful poker player's strategy. In trading having and/or executing a stop loss on every trade is the same thing as folding in poker. It is a necessity for any trader's long term survival to trade with stop loss orders on every trade.

In fact, I see a lot of parallels between trading and poker and you cannot view trading as radically different from the stock market. Yes, you take the other player's money in poker when you win. When you have a stock that goes up, your company may be taking business from another company and affecting its share price, causing other people to lose money. Our actions affect everything and money swirls around in this global money pot. I'd suggest that anyone interested in trading try to master poker first. The skills, the psychology, are transferable. If you can't master poker, you probably can't master the market. Some poker players will use systems and programs to analyse opponents' hands and provide them with a rough idea of what style of player they are, but they do not help you win. Poker is about adapting and players will switch up their strategies constantly. The systems are also next to useless versus bad players because they have no rhyme or reason behind what they do. You don't need the programs to tell you someone is bad. It becomes blatantly obvious within a couple hands of play and that is all the information a player needs. 'If you don't know who are you, the market is an expensive place to find out.'

I've also read an analysis that suggests that military leaders would also make good traders. War is 90% boredom and 10% intense action. It also requires enormous discipline, sudden and violent action, courage under fire, the ability to make life-and-death decisions with incomplete information, and an unshakable belief in the correctness of what one decides.

Lastly I always had the inkling that salespeople would make great traders. They understand that they have to go and give X presentations a week and know that not all will end up as sales. They know that Z% of potential calls end in sales. So, they are used to the idea that not all situations result in a positive outcome.

They know that if they stick to their sales pitch, and repeat it, they will get a hit. And the hit will compensate for the losing pitches. Those on commissions are already used to the idea that income can fluctuate. (as opposed to those salaried types who feel they are entitled to something just because they turned up at the office, and try to force the market to pay them). Downside is that they may feel they can "talk" their way into a sale, i.e., they may have a misguided belief they can influence the outcome, rather than react to it.

It is sometimes said that professional people like doctors, scientists...etc make terrible traders because they need definitive results; results that can be quantified, being right takes precedence over trading. They tend to be wrong for longer than those who understand being wrong in analysis (any type of analysis) is all part of the trading process. What you do when you're right and what you do when you're wrong plays a most important role.

Of course success in one field or certain attributes in one field do not equate to success in another. A solid background in something is good for anything in life but does not mean it can be applied to something else. More a natural instinct to take something up easily with a lot of work. However certain attributes should give those with them an understanding of what is required to 'run the business' of trading.

The really tricky thing is that in the 'real world' people often become successful by denying their limitations and letting their egos run riot. I guess this is one reason that the translation from business success to trading success often ends in failure.

Trading (unlike investing) is a ZERO SUM GAME, someone has to lose for someone to profit. Sorry win-win doee not work in this business, it is dog eat dog. If you decided to buy or bet on 5,000 Barclays shares someone has to sell those shares to you, you always have to have two parties. Someone will gain from someone else's losses. Fortunately in the trading world everyone does not have the same opinion and that is what makes a market, I may think the that FTSE is going up today, you may think it is going down.

Q. Are there any games which could help me improve my trading skills?

A: Undeniably, more people lose in trading than win but we all see the same prices at the same time, this holds for all traders around the world so ask yourself, why does a person win consistently while another one keeps losing?

Poker and Stock Market Trading

This can also be seen in the popular game of poker, more people lose than win, this happens year-in year-out and every single day, yet, the same people consistently get near or at the top of the tournament boards. Surely the game is not rigged (unless you are playing at AbsolutePoker ), they all get random cards yet it is not the cards you get...it's how you play them.

Many of the decisions we make in life are intrinsically linked to risk versus reward problems. Take unsafe sex for instance. In the past I had taught my son the rudiments of pot odds in poker and every time a decision had to be made the question was always the same 'How big is the pot and how much do you have to call?'. Same goes for the safe sex topic. The argument went something along those lines: 'The likelihood of you contracting HIV may be low; but the price is your life'. This is a stake you don't want to play; use a condom all the time'. I distinctly recall my son forgoing on a social gathering with friends when he had an important exam at school the next day. 'Thought you were going out.' 'Nope - big test tomorrow and I need to study. My enjoyment of going out tonight wouldn't be anything compared to the pain I'll feel tomorrow.' This is a pure risk/reward calculation, and I silently did the parenting victory dance.

Is poker predictable? No. It's not straightforward, otherwise there would be many fewer poker games running (why play if it's just obvious your opponent is better than you?). Tournaments aren't usually considered to be a meaningful indicator of skill in any way due to the extreme amount of variance involved in them (sufficient sample size has probably only been attained by online players who've played 10 a day every day for years). Texas hold'em is still unsolved, so theoretically edges should remain available. On a practical level these edges are probably miniscule at the very high levels these days. The pros realise this of course, so high stakes play increasingly revolves around Omaha, a more complex 4 card variant of the game. Good players going into Omaha is not because it's more skilled than hold'em. Just because there are more hand permutations (i.e. more randomness, less skill) does not make it a more complex game strategy-wise. If anything, it de-skills post-flop play because any hand-reading abilities are limited. Omaha is a relatively new game that is gaining popularity, and thus the distribution of skill is skewed more towards "noobs" than hold'em, so there is more value there to be exploited. Of course the game involves randomness and luck, which is why no one ranks people on the basis of 1, 100, or even 10,000 hands. All the top cash game players have played probably nearing or in excess of the 1 million hand mark lifetime, enough to eliminate the randomness factor and survivorship bias.

Well, that's another way poker might be like trading: It's easy to participate, difficult to sustain success. Many simply play for the thrills of winning and losing; but few systematically learn from experience and improve their skills over time. Another point in favour of edges is that sometimes (and more often as you go up stakes) a triangle system originates because of particular inefficiencies being exploited to different levels by opponents e.g. A can beat B, B > C, but A loses to C. Another point in favour of edges is that sometimes (and more often as you go up stakes) a triangle system originates because of particular inefficiencies being exploited to different levels by opponents e.g. A can beat B, B > C, but A loses to C.

Poker also helps you to deal with incomplete information as you often don't know the complete picture - some people are painfully insistent to know all the little bits and pieces about a problem before working on a solution. In this regard poker forces you to make a decision based on outcomes and probabilities. If you know the probability of an event and the reward associated with an outcome you can make the best decision based on the information you have at your disposal (at that moment) even though what happens after may be largely out of your control. Understanding this fact in poker helps you understand the equally immutable fact of life.

Not only that but poker helps you to deal with bad things like bad beats which happen to everyone. Horrible things happen to wonderful persons. For instance a drunk driver hits your friend's car, and she is paralyzed for life - the ensuing suffering seems so random and unfair that it may disrupt people's sense of direction. Of course losing a two-outer is insignificant to losing a close friend but if you understand that the cards don't have it in for you, sometimes you can carry that that lesson to the world around you. To understand that fate really does not have it in for you either. That this grotesque, random, totally unfair pain that we endure is indeed random, and is an integral part of existence. These are the rules of logic and mathematics over emotion and this is where poker can help you in your trading.

'...Good poker players are far more likely to make good traders than clever economists or accountants... They don't realise trading is like a card game, it's you against others. Economics doesn't come into it...' - Oscar Wilde would've liked that one for himself.

Footballers vs Tennis Players

On a different scale it is interesting to watch the difference between footballers and tennis players. The tennis players have far more mental discipline than footballers. Footballers blatantly cheat in the hopes of getting away with it for 90 minutes then look so upset at being booked or sent off. Very few Footballers rely totally on their skills without resorting to shirt pulling, pushing and tripping. They also seem to get more easily frustrated when things go against them. Tennis players by contrast can't hide their shortcomings behind 10 other players. They are held to account for every single shot and rely almost totally on their physical and mental preparation. Since traders are unlikely to get away with cheating and need be disciplined in their action for every trade I would say traders have far more in common with tennis players than footballers.

As a sidenote in sport the best players have the ability to think two or three moves ahead, I always try to do this with my short-term trades, obviously it doesn't always come off but when it does I can put my plan into action and make instant decisions, because I'm sure you have seen as things are unfolding you can't exactly study a chart for a few minutes and think yes i will do this or that, the market moves too damn quick, all too often we can look back at a trade and go oh yeah I should have taken profits here or put a stop here, but in the heat of the battle we don't have that hindsight.

Chess and Bridge

Let's compare this to two other games: chess and bridge -:

Chess is a battle of wits, whereas bridge is a conversation between four players with very strict rules and structure that have to be learned and observed. The best players are simply those who are able to apply the rules better than the crowd. It's also mathematical in that play often depends on probability - the best players simply know, given the conversation (bidding) and the cards that they can see, the likely lay of all of the cards...the rest of us just do our best! I would say that chess is more creative; bridge favours those who can follow rules (and most of us can't...just as with trading systems).

Last Tip

Do you want to increase your mental sharpness? Working logic puzzles can also help to strengthen your brain. Go home and do some Sudoku puzzles :-)

Intelligence, like a muscle, grows stronger through exercise. 'There's no such thing like fixed intelligence', Carol Dweck a Stanford psychologist says. ' People who attribute their failures to insufficient ability become discouraged even in areas where they are capable. Those who think simply they do not try hard enough, on the other hand are fueled by setbacks.' Through more than three decades of continous research, Carol has been researching out answers as to what leads some people accomplish their potential while others equally talented don't - 'why some become Muhammad Ali and others Mike Tyson.'

The key, she says, isn't ability; 'it's whether you look at ability as something inherent that needs to be demonstrated or as something that can be developed.' What's more, Dweck has demonstrated that people can learn to adopt the latter belief and make impressive strides in performance. 'Students for whom performance is paramount want to look smart even if it means not learning a thing in the process. For them, each task is a challenge to their self-image, and each setback becomes a personal threat. So they pursue only activities at which they're sure to shine - and avoid the sorts of experiences necessary to grow and flourish in any endeavour.' This is where 'learning goals' trigger a different chain of thoughts and behaviors to 'performance goals' This leads us to the achievement goal theory. 'Common sense suggests that ability inspires self-confidence. And it does for a while as long as the going is easy. But setbacks change everything. Lots of students who put forth lots of effort don't make any attributions at all. They don't think they are failing - failure is information - we label it failure but it's more like 'this didn't work. I'm a problem solver, and I'll try something else.'

Q. What do you think is the biggest obstacle to a successful experience as a private trader?

A: This is a hard question to answer. One of the biggest obstacles is finding out what is right for you. You will lose money finding out. Finding a winning strategy is hard. Believing in it is harder. Then when you find a strategy you have to stick with it and that is the hard bit - discipline. Holding firm when your trade is working against you is very hard to control. Letting it go when/if it stops working is tough. Admitting it wasn't a good strategy to start off with humbling.

The reverse is also true. Take a recent personal example bought DTY at £7.02 currently up 33 points now do I sell for a 35 point profit or ride it, only time will tell, however if you asked me on Sunday, 'Andy, would you be happy with 35 points on a 3 day trade answer yes I would settle for that would be the answer'. However, greed can be hard to battle and one that is harder than the market most times.

So in no particular order -:

  • Not having enough money to start with
  • Poor risk management
  • Poor money management
  • Poor judgement
  • Poor system, or wrong system for 'now'
  • No instinct for trading
  • Attitude to losses
  • Ego
  • Pride
  • Greed
  • Fear
Also, examining the situations where people get themselves into deeper trouble than they thought possible, it always involved one or more of the following:
  • Poor preparation
  • Poor information
  • Decisions compromised by ego or overconfidence
  • Under skilled relevant to the challenge
  • Insufficient/ incorrect tools
  • Bad luck
  • Insufficient or no contingency plan

By putting in the effort to understand the mechanics and terminology of spread betting and knowing how to use your trading platform you will be able to avoid many of the most common mistakes. Most of the others can be avoided by taking care when placing and amending orders and keeping your emotions in-check.

Good luck and if you are new to the game, keep the stop losses on until happy to lose your stake and sleep at night ;)

Thank you for your continued interest in our spread betting trading portal, and allow me to invite you all to continue writing in with your questions, comments and feedback which you can address to traderATfinancial-spread-betting.com. As we push forward and experience further growth, always know that we appreciate your interest, your curiosity and your drive to explore the depths of investing and trading.

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