How to Fail as a Trader

The two biggest causes of failure among new traders are bad trading systems and unfettered emotions.

Bad Trading Systems

Trading is a game of probabilities and sequence of returns. Systems run the gamut from trend following and breakout systems on one end that have low win rates but (hopefully!) big winners to short-term mean reversion systems that have lots of small wins with losses that aren’t too large. Stanley Druckenmiller said he only targets trades that will return 5x his money so he only has to be right slightly more than 20 percent of the time to make money. But the only way a system like this works is if he has a bunch of small trades going at the same time so he doesn’t get wiped out with losses while waiting for that 5x trade to happen. Too many traders accept small wins and big losses. They trade positions that can permanently go to zero and they compound the issue by using stop losses purely based on price. Even if 90 percent of your trades are profitable, the remaining 10 percent of trades that are losses can more than wipe out your gains.

Emotions

The second most common cause of failure for new traders is decisions made because of panic or euphoria. If a trader’s position goes against him, oftentimes a new trader will sell out at a loss just to see the trade bounce back. To be a successful, a trader has to have a plan to manage the position no matter if it goes up or down, and be able to stick with the plan no matter what.

Euphoria is just as bad as panic. Occasionally a trader will find himself in a situation where seemingly everything he touches turns to gold. Profits are easy and account balances grow. Instead of taking the good fortune in stride, knowing that the hot hand will eventually end, he increases his position sizes, uses leverage, or goes outside his area of expertise. The end result is easily anticipated as the new trader circles back to panic.

Emotions can be tamed by trading small until you can handle the losses that will inevitably happen on any single trade. Slowly increase the size of the trade and the size of the losses that you incur. If you panic sell, lose sleep, or want to check prices every 30 minutes then your position size is too big.

 

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s