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It is a common quoted statistic within the industry that in the region of 90-95% of traders/investors in the financial markets fail. Conceptually, trading stocks online looks to be an easy pursuit. With hindsight the price swings are easily identifiable and thus should be profitable and yet the above failure rate shows this is far from true. A bystander could reach the conclusion that this group of people must be gamblers of low intelligence, even stupid, considering that many within it will continue in this vain pursuit year after year, repeatedly following the same path.
Albert Einstein once said, “The definition of an idiot; someone who repeatedly does the same thing, but expects different results, not learning from the experience”. Yet this group will persuade themselves that
o it’s all part of the education process,
o the next system/methodology will be different – it will work,
o I’m determined not to give up, I’m not a failure and will ultimately succeed,
o I was unlucky …… the list could go on.
However, far from been of low intelligence or stupid, the profile of this group is in fact more often than not one of, well educated professionals, middle-class, successful business or career people of medium to high net worth. Typically, they are successful in other walks of life, particularly in their career or business and yet they fail to make a successful transition to a trading career. Furthermore, they spend vast sums of money on trader education typically accumulating a vast library of trading books and attend numerous expensive training courses and yet they still continually fail. With these apparent advantages why is it that they continue to fail (and on many occasions spectacularly so) over a prolonged period of time? The answer is that they attribute the failings to the wrong aspect of trading and incorrectly focus on resolving this. The 3 main aspects of trading are;
o the “Psychology” of trading,
o the “Methodology” or Systematic approach to entering/exiting trades,
o the “Money Management” of funds.
However, most people focus almost exclusively on the “methodology” (or system, often primarily using technical analysis) and give scant regard to the other two interrelated and more important elements. Consider a “system” that has a win/loss ratio of 50% and also a risk/reward ratio of 1:1. Such a hypothetical system is equivalent to “tossing-a-coin” and as such, ignoring transaction costs, would merely deliver break even returns and yet this is an inherently better performance than the majority of the trading hopefuls. However, most traders would argue (probably correctly) that from the knowledge and experience gained from studying technical analysis that firstly their win/loss ratio was better than 50%. That is, when planning and entering a trade they have used their skill and judgement to ensure that more often than not it will move in the direction they want. (If this were not true than you may as well toss a coin to determine when to trade!). Just a modest increase on tossing a coin, say 60%, meaning achieving 6 out of 10 winning trades should be easily achievable by applying correctly just a little knowledge. Secondly, they would argue that they can plan a trade that would have an initial minimum risk/reward ratio of 1:2, ensuring that on average, winning trades would be twice as profitable as any lossing ones. Given just a modest win/loss ratio of 60% and a risk/reward ratio of 1:2 most traders would be happy with achieving this (certainly as a launching point to a successful fulltime career). If most traders stuck to their “rules” they probably could in fact achieve comparable results however, in practice, other factors take over; greed, fear, ego, hesitation, hope ……
Whatever the good intentions of the initial plan, quickly the “Psychology” of trading becomes the most important aspect. It is an individual’s personality traits that are ultimately the determinate of the success or failure in the execution of any system or methodology. Simply put, they don’t stick to the plan for a variety of well documented reasons. This also has a dramatic impact on the “money management” side of trading. It becomes non-existent, unquantifiable and certainly impossible to do a risk assessment going forward when the trading style has become virtually arbitrary. If aspiring traders would only analyze past trades critically to categorize if it were in fact the system that failed or the failure was in the execution of the rules, then much progress would be made. However, this leads to another failure of novice traders in that a trading log/diary is seldom kept to allow this crucial evaluation.
Wall Street ATM 