A majority of civilian financial market traders lose money, some break, and some profit consistently.
The Big Q: How do they do it?
The Big A: There is no magic formula, but there are fundamental flaws that stop most traders from being consistently profitable.
Below are some of the reasons that people fail at trading as follows (an excerpt from Jeffrey Kennedy’s Trader’s Classroom Collection);
Another Big Q: Why Do Traders Lose?
If you have been trading for a long time, you have felt that a monstrous, invisible hand sometimes reaches into your trading account and takes out your money. It does not seem to matter how many books you buy, how many seminars you attend or how many hours you spend analyzing price charts, you just cannot seem to prevent that invisible hand from taking money out of your trading accounts.
Which brings us to that Big Q: Why do traders lose?
Whether you are a seasoned professional or just thinking about opening your 1st trading account, the ability to stop the Hand is proportional to how well you understand and overcome the 5 Fatal Flaws of trading.
For each fatal flaw represents a finger on the invisible hand that wreaks havoc with trading account money.
Fatal Flaw # 1 – Lack of Methodology
If you aim to be a consistently successful trader, then you must have a defined trading methodology, which is simply a clear and concise way of looking at markets. Guessing or going by gut instinct won’t work over the long run. If you don’t have a defined trading methodology, then you don’t have a way to know what constitutes a buy or sell signal. Moreover, you can’t even consistently correctly identify the trend.
How to overcome this fatal flaw? Answer: Write down your methodology. Define in writing what your analytical tools are and, more importantly, how you use them. It doesn’t matter whether you use the Wave Principle, Point and Figure charts, Stochastics, RSI or a combination of all of the above. What does matter is that you actually take the effort to define it (i.e., what constitutes a buy, a sell, your trailing stop and instructions on exiting a position). And the best hint I can give you regarding developing a defined trading methodology is this: If you can’t fit it on the back of a business card, it’s probably too complicated.
Fatal Flaw #2 – Lack of Discipline
When you have clearly outlined and identified your trading methodology, then you must have the discipline to follow your system. A Lack of Discipline in this regard is the 2nd fatal flaw. If the way you view a price chart or evaluate a potential trade setup is different from how you did it a month ago, then you have either not identified your methodology or you lack the discipline to follow the methodology you have identified. The formula for success is to consistently apply a proven methodology. So the best advice I can give you to overcome a lack of discipline is to define a trading methodology that works best for you and follow it religiously.
Fatal Flaw #3 – Unrealistic Expectations
Between you and me, nothing makes me angrier than those commercials that say something like, “…$5,000 properly positioned in Nat Gas can give you returns of over $40,000…” Advertisements like this are a disservice to the financial industry as a whole and end up costing uneducated investors a lot more than $5,000. In addition, they help to create the 3rd fatal flaw: Unrealistic Expectations.
Yes, it is possible to experience above-average returns trading your own account. However, it’s difficult to do it without taking on above-average risk. So what is a realistic return to shoot for in your first year as a trader – 50%, 100%, 200%? Whoa, let us rein in those unrealistic expectations. In my opinion, the goal for every trader their 1st year out should be not to lose money. In other words, shoot for a 0% return your 1st year. If you can manage that, then in year 2, try to beat the DJIA or the S&P 500. These goals may not be flashy but they are realistic, and if you can learn to live with them, and achieve them you will fend off the Hand.
Fatal Flaw # 4 – Lack of Patience
The 4th finger of the invisible hand that robs your trading account of money is Lack of Patience. I forget where, but I once read that markets trend only 20% of the time, and, from my experience, I would say that this is an accurate statement. So think about it, the other 80% of the time the markets are not trending in a clear North/South direction.
That may explain why I believe that for any given frame, there are only 2 or 3 really good trading opportunities. For example, if you’re a long-term trader, there are typically only 2 or 3 compelling tradable moves in a market during any given year. Similarly, if you are a short-term trader, there are only 2 or 3 high-quality trade setups in a given week.
All too often, because trading is inherently exciting, and anything involving money usually is exciting, it is easy to feel like you are missing the party if you do not trade a lot. As a result, you start taking trade setups of lesser and lesser quality and begin to over-trade, and then lose money.
How do you overcome this lack of patience?
The advice I have found to be most valuable is to remind yourself that every week, there is another trade-of-the-year. In other words, don’t worry about missing an opportunity today, because there will be another one tomorrow, next week and next month … I promise.
I remember a line from a movie in which 1 character gives advice to another on how to shoot a rifle: ‘Aim small, miss small.’ I offer the same advice in this new context. To aim small requires patience. So be patient, and you will miss small.”
Fatal Flaw # 5 – Lack of Money Management
The final fatal flaw to overcome as a trader is a Lack of Money Management, and this topic deserves more than just a few paragraphs, because money management encompasses risk/reward analysis, probability of success and failure, protective stops and so much more. Even so, I would like to address the subject of money management with a focus on risk as a function of portfolio size.
Now the professional traders tend to limit their risk on any given position to 1% – 3% of their portfolio.
If we apply this rule to ourselves, then for every $5,000 we have in our trading account, we can risk only $50-$150 on any given trade. Stocks might be a little different, but a $50 stop in Corn, which is 1 point, is simply too tight a stop, especially when the 10-day average trading range in Corn recently has been more than 10 points. A more plausible stop might be five points or 10, in which case, depending on what percentage of your total portfolio you want to risk, you would need an account size between $15,000 and $50,000.
Simply put, I believe that many civilian traders begin to trade either under-funded or without sufficient capital (money) in their trading account to trade the markets they choose to trade. And that does not even address the size that they trade (i.e., multiple contracts).
To overcome this fatal flaw, let me expand on the logic from the ‘aim small, miss small’ movie line. If you have a small trading account, then trade small. You can accomplish this by trading fewer contracts, or trading e-mini contracts or even stocks. Bottom line, on your way to becoming a consistently successful trader, you must realize that one key is longevity. If your risk on any given position is relatively small, then you can weather the rough spots. Conversely, if you risk 25% of your portfolio on each trade, after 4 consecutive losers, you are done, and out all together.
Break the Hand’s Grip
Trading successfully is not easy.
It’s hard work … very hard. And if anyone leads you to believe otherwise, run the other way, and fast. But this hard work can be rewarding, above-average gains are possible and the sense of satisfaction a person feels after a few nice trades is absolutely priceless. To get to that point, though, you must 1st break the fingers of the Hand that is holding you back and stealing money from your trading account. I can guarantee that if you attend to the 5 fatal flaws outlined, you will not be caught Red-handed stealing from your own account.
Jeffrey Kennedy is the Chief Commodity Analyst at Elliott Wave International (EWI). With more than 15 years of experience as a technical analyst,
Remember, the name of the trading profession is to make money. It is your money and so, your responsibility.
Have a terrific weekend.