Why do most Traders lose Money?

Own Experience & Observations

The world of trading is often viewed as a lucrative field, promising substantial financial gains. However, the harsh reality is that many traders lose money. It is an irrefutable fact that a high degree of retail customers lose money in trading. Interactive Brokers (UK) states that 67.6% of its retail clients lose money when trading CFDs (contracts for difference). The trading platform eToro suggests an even higher number of 74%. This is a staggering amount.

In any zero-sum game, there will always be winners and losers. It can’t be a coin toss, as this would involve no skill whatsoever. The good news from the statistics above is that the numbers would suggest that a certain skill is required, and that makes sense. Looking at it from the flip side, around 20-30% of traders seem to be making money. Now, those statistics don’t tell us much about the variability of those numbers and the transitionary nature of individual traders, as it is simply a sample statistic. The reality is possibly way more extreme than those figures would suggest. Luck, of course, can have a role, but it can’t be compounded over time. Please read my article “On Luck” below for more details.

I would also suggest to read my post “On Edge” for further reference.

So, why do most traders lose money? If you search the information superhighway, you will find the typical reasons, which are all true but may not help you much. Therefore, I will add my personal experience to the mix, hopefully giving you a little more insight.

The most important aspect many leave out is what I refer to quite often in my writings, namely, everyone’s personal journey. We are all very unique, so our path to becoming the best possible investor/trader will look vastly different. One thing, however, is for certain. That is there are no shortcuts and that everyone will have to endure pain along the way. It will catch you sooner or later, and it’s up to you to learn from it. If you don’t, you won’t improve; it’s as simple as that.

Source: Dall-E

My journey started possibly quite similarly to many, I would guess. Having saved some money, I was off to a great start, hitting a few winners early on, only to be taught a heavy lesson later. Mine started with trading options, above all things, in the late 90s. I knew the basics from University, but I had never traded them before. I didn’t know about the settlement procedures, about how volatility and time decay in real-life can really move quickly against you. I lost a lot of money during the Asian crisis in the late 90s. I had nobody else to blame but myself. I pretty much made all the errors one can make. Also, I had nobody really to learn or at least get advice from.

Breaking down the various factors which are inhibiting us on our journey, here are the ones which I think signify the main drivers that stand between our success and failure:

Knowledge and experience:

• Inadequate understanding of markets: I would certainly say that the difference between subjective and objective knowledge is something that has fooled me. I might have had a degree of theoretical understanding, but this will not help anyone much in the real world. Understanding starts with experience. When you start, start small. Have an idea of how the system works.

• Overtrading: We all fall victim to this often futile endeavour. Overtrading is a sign of insecurity and a lack of ability to withstand normal market volatility. Journal your thinking and trading, which will help you analyse your experience retrospectively.

• Ignoring proper risk management: Yes, we all set-out with good intentions, but they often leave us during the process, doubling-down on bad trades was a mistake I often made. I also wasn’t strict enough on my loss-taking discipline. In short, the lack of a proper risk-taking process will be found out sooner than you think or you can afford. Write it down, remember it, adhere to it and adjust if its not working.

• Chasing quick profits: Trying to get rich quickly with risky strategies often leads to significant losses. This is possibly the most common error many make. Wrong trade sizing coupled with bad risk management is a recipe for disaster. Don’t even start if you haven’t considered this aspect properly. I chased and failed many times over.

• Leverage: Similar to the above, people do not really understand leverage. It all sounds lucrative to risk small amounts in order to chase outsized returns. Studying the probabilities of such payoffs vs. the inherent probability of a shortfall should make it pretty obvious how dangerous such an undertaking is. If you’re inexperienced, don’t use leverage. Once you reach a more mature stage, use it wisely. I to this day, only use leverage sporadically.

Psychological factors:

• Not knowing yourself: Probably the most encapsulating aspect of them all, as it will come only through the teachings of time. Everyone’s personal journey leads to ultimately knowing more about yourself. The more you know, the better your process will become.

• Greed and fear: These powerful emotions can cloud judgment and lead to impulsive decisions like chasing profits or holding onto losing positions too long. We have all been there. I’d say fear was a more powerful emotion in my learning; not attacking a trade or taking losses too early is equally damaging as being overly greedy when things are going your way.

• Overconfidence: Overestimating your skills or knowledge is a common pitfall and results in the necessary humbling of anyone’s ego. Markets will humble you, don’t worry. Over time, you will appreciate this fact.

• Common Sense: I have seen the most intelligent investors fail because they didn’t apply any common sense. You can’t train it, whether you have it or not. Apply it to everything and question your logic continuously.

Additional factors:

• Lack of realistic expectations: Trading should be viewed as a long-term endeavour, not a quick way to get rich. Shooting the lights out every year is basically impossible. Aiming to post achievable returns over multi-year horizons is the way to go, in my opinion. Consistency is key and will determine the success rate ultimately. Power of compounding at play.

• High competition: Professional traders and algorithmic systems create a very competitive landscape for individual investors. Where there is money, it will inevitably invite an almost unlimited amount of competition to the complexities of the game. Knowing who is on the other side of your table is as important as knowing the game itself.

• Information & Resources: Needless to say, the vast complexities of the investment universe are hard to grasp. Knowledge is powerful, but you must also understand that financial markets are not rational, and their behaviour can be brutal and rapid. Complex systems are impossible to forecast or tame. I learned to understand that the beast has a life of its own and that it certainly doesn’t care for anyone’s profit or loss. Having proper information and research, while important, will not grant you above-average results. Any information will usually be already in the price. With technological advances, obtaining good information is relatively easy these days. What is more dangerous, however, is not to get entangled in bad information or biases proclaimed to be gospel by many of the investment gurus out there. Avoiding bad mistakes, as Charlie Munger would say, is equally and possibly even more important in succeeding.

---

Conclusion

There you have it, and I truly hope that some of my personal experiences will help on your journey. Paper Alfa was founded on the very principle of helping others to succeed. Free educational content coupled with thought pieces and experiences from my past are the core pillars of what I provide, and this is only the beginning. I have plans to expand the offering with new additions early next year.

If you are after further and more detailed content, consider becoming a subscriber. For paid subscribers, my models are providing insight into the likely paths of a variety of markets going forward. Founding members have the additional benefit of having regular chats with me. It is up to you where you want to take it. Some are simply using me as a sounding board for advice on their professional journeys, while others want my input into their own investment process. I am truly honoured to help each one of them where I can. I am also considering opening up a purely professional service for firms.

If you want to remain a free subscriber and receive my posts, that is totally fine by me, as I am thrilled to have you on my journey. My free posts are hopefully giving you enough to propel you forward, and there will still be a continuous stream of free content coming your way.

Always remember that the future is bright, and the best is yet to come.

Best of luck out there!