Stock market : The real reasons behind the failure of the small private traders

We see in virtually all the publications that try to analyze the factors behind the failure of the vast majority of the individual traders with very important figures as (+ 85% of the private traders to the US lose all of their accounts), or (90/90/90 ie 90% of traders lose 90% of their capital for 90 days).

The reasons behind these results are known and they are generally right of course, but in this article I add other very important elements that we tend to forget, and that we will put together, to better understand these results.

If I can really summarize the big difference between the individual trader of forex or stock market and the professional trader, I can say that the approach to their activity, is the one that determines why the particular individual loses all the time. Moreover, this approach also plays a role on the psychological side, which weakens from the beginning (The mentality, the practices, the sources of information put the particular trader in the box of the great probability the failure at the beginning.

1 – The global approach

One of the first aspects of this difference is to focus only on the short term with day trading and scalping, looking for ” action ”, and quick completion of the position taken within minutes and even coming seconds (multiple screens with full graphs and market depth data, news and watch every tick on the market ..), believing they simulate professional traders in investment banks or practices that do not no longer exist in the floor of the Chicago Stock Exchange, confusing the market making activity with the proprietary trading activity.

The first is taken for short terms and its purpose is to generate commissions and do business with customers of the bank, either by doing a simple execution of orders (ie intermediation without taking risk), or by taking the risk by offering liquidity (the counterparty), and this results in a portfolio in which there are assets that the trader ” does not want ”, but for which he is obliged to find the best possible prices to limit the probable losses (the retention ratio). We have a strong use of algorithms, because the human intervention is limited, unfortunately the particular traders prefer to compete in these durations with these algos of the banks and other market makers, or the HFT (High frequency trading), in n ‘ having neither the tools nor the capital to do it and guarantee good probabilities of gain over the long term.

The second activity is managing bank money and its investors, and for that, traders (who are called portfolio managers) develop portfolios that contain several assets for periods ranging from a few weeks to a few months, and rely mainly on fundamental analysis to decide their biases, and the technical one as a timing mechanism and more advanced parameters for risk management.

Traders in the vast majority of hedge funds do the same thing, they do not make their decisions through a technical indicator or chartist figure, but through ideas and themes, using a process that encompasses several elements.


2 – Understand the concept of volatility and leverage

Because it trades short term in an environment of low volatility (especially with these low historical levels), the particular trader seeks to compensate for this lack of volatility by the leverage (granted with great pleasure by the broker), and so when the course passes in the opposite side, it appears at the level of the PnL as if it loses a lot, which pushes it to close its position earlier, even if the course continues after in the initial direction. This is noted on his studies, showing that losing traders still have a good percentage of success relative to the chosen direction. When the price passes in the opposite side the trader lets the position run (by which in fact there is no volatility), but when it takes the right direction the PnL shows a good gain compared to the size of the account (created by leverage), it closes the position quickly.

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3 – Lack of support for their approach with figures for very important elements such as (statistical distribution of returns, volatility, risks, probabilities, etc.)

Professionals have a certain ” mathematical rigor ”, which determines the durations of their positions, the degrees of risk and correlation.

They take positions for long-term durations, not just because it’s at this level where the fundamental vision is clearer, but to try to achieve more volatility and let the gains run for weeks and months .

This volatility, which does not exist in these very short durations, and when a nonvolatile asset is traded all the time with leverage effect, results in faster losses if it moves a little more during a news or announcement of the few figures.

4 – To follow some techniques of graphic or technical analysis is to name them “strategies”:

No trader or portfolio manager gets up in the morning, opens his charts and decides to take a position by what a technical indicator or chart figure X or Y gives him a signal to do it. The technical analysis is only a tool for timing the trader’s ideas and fundamentals, and only in the minority of the time spent in the overall analysis before the decision-making.

The internet is FULL of thousands of techniques with different indicators and names, or methods of scalping the market from tape and other volume elements … etc. But the concentration and analytical work of the professional trader does not pose especially on that. Technical analysis is widely used by what it is easier to understand and market to an individual who wants to learn this activity.

5 – Information overload and distractions:


Pay a lot of attention to what is very marginal and unimportant like the platform, spread, commissions, screens and setups, details in platforms, paid services that adds nothing (twitter feed, live squawk audio, details at level of the parameters of technical indicators), these tools and these details do not create a good trader, but the opposite it becomes only a source of distraction, but it is what we find unfortunately the most on social networks and internet pages.

What is loved and sponsored by brokers and entities looking to take your money.

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6 – Take a directional approach and pay attention only to the risk (supply / demand) of the asset, while there are others that impact the latter (sector risk, market, correlation with raw material … etc.), ie there is a lack of diversification and correlation.

Professionals use portfolios and try to win regardless of the direction that the market or asset can take, after to reduce the size or stop the losing positions and add to the winning ones. Contrary to what is common on several forums and videos on the internet, saying that trading in higher time units is more risky, which shows that these people do not understand anything about risk. The latter can be hedge for months with assets that are correlated.

7 – Trading as a source of income:

This is one of the very important points in the destruction of the financial and mental capital of the particular trader. Unfortunately we see many people, and even “educators” who talk about withdrawing money from the account to live trading or to spend part of the earnings.

He who knows the markets, he knows very well that it is a world of uncertainty. We can never guarantee earnings and a fixed salary from performance.

Even professionals, whether they are the best or the worst performers, require a management fee, which is used to pay for the infrastructure (salaries, miscellaneous expenses, etc.), whereas we see an individual who has learned for a few months or even a few years, wants to live from his performance!

Hedge funds treat this as a business, they do not withdraw their earnings (permanent reinvestment), they charge a management fee (0.5% to 2%) and they seek investors all the time to make the capital under management even more important. .

As private traders, we do the opposite!

What is acceptable is to have another small account from which you can withdraw the gains (expect it to be destroyed at any time), and never touch the main one, and at the same time not leaving your job will remove the pressure. In addition, the elaboration of the portfolios does not require that one remains fixed all the time in front of the screens.

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Proprietary trading companies or ” prop trading firms ” are not defined in the ” smart money ” category, simply because they lack the financial capital and human capabilities of hedge funds and investment banks, and their business model is completely different from these entities, because they gage mainly through different fees (office and software rentals, percentage on earnings, broker commission with which they do business, training costs, etc.). Their earnings do not come from their performance (no trading company will give money to traders after only a few months of their start, without having a guarantee and other sources of income). If this is not the case, they will train hedge funds or even SMAs (Structured Managed Accounts) and look for investors instead of waves of newcomers to the world of trading (forget about marketing and advertising!)

All this distraction and bubble in which the particular trader is, push him to react with the way that the entities that operate with a conflict of interest want him to do. Because if the broker says to him not to trade every day, and to open and to close dozens of positions not day, or not to use this or that service because it is not useful they will not do any thing business.

If an educator asks these clients to focus more on a complete process and not a few techniques on the charts or the 70’s order book, then nobody will buy his course or his training.

Our problem is that we want to hear what makes us happy, and not the reality.

All of the items cited combined give us a trader with low probability of success and consistency in this activity. You have to think about doing the opposite of seeing yourself and hearing all the time on the internet and social networks.

When we understand how this infrastructure works, and where the interests of each entity reside, we can know what not to do and the mistakes to avoid, and from there to the stage of looking how to win.

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