Why do so many stock market traders go broke?
As noted elsewhere on this site, the statistics relating to traders are quite shocking. The numbers located by your author suggest that:
> 80 percent of traders last less than a year
> 90 percent of all new traders lose all of their capital within the first year
> over 90 percent of all traders fail
These numbers actually relate to commodity traders rather than those specialising in stocks, but clearly there are some very strong parallels at work here.
It seems reasonable to suggest that the majority of new traders are not aware of these statistics - otherwise far less people would begin to trade commodities each year! Either that, or many, many people have an over-inflated view of their own knowledge and skills. Who knows which?
In psychology, this is known as the "Lake Wobegon effect" which the habit that we humans have to overestimate our knowledge and skills relative to other people.
We are not trying to judge or moralise - we just want to get as many of the facts into the open as we can, in the hope that you, the reader, can make informed decisions about your own investments.
One thing though is for sure - lots of stock market traders go broke.
There may be several reasons why stock market traders fail and we submit that almost certainly the main one is psychological. This might seem strange to suggest, but for many people, gambling and trading are remarkably similar.
In the UK, the gambling industry has admitted that around 93 percent of all regular gamblers on both horse and greyhound races lose money consistently. Lets all be clear, that is a very large percentage. Many people opposed to gambling would suggest that 93 percent is a low estimate...
One thing is for sure, when one of the tools of your trade is money, it's value must take on an unusual role in the mind. After all, if most stock market traders, or gamblers - even successful ones - were to think to themselves that, "This trade (or bet) is worth more than most family cars", they may be a little more circumspect about the way they put it to use.
Instead, they bet it on the turn of a card, or the movement of a stock or index - events which are almost certainly beyond their control. Then they do it again and again.
It is the belief of your author that this ability to keep going again and again, even when on a losing streak - and they happen to everyone - is what makes for serious losses.
It is also the desire to cover up such losses inside investment banks (whether out of pride, shame or to protect bonuses) that has lead to many of the fraudulent activities that ultimately bring such firms down. Examples such as Nick Leeson at Barings Bank and Jerome Kerviel at Société Générale make the point.
Those that take part in the short-term market movements we discuss and survive for the long-haul are almost certainly people that make lots and lots of very small - successful - trades. As such, no position is so large that it may 'wipe you out', but instead they bank little profits every day.
These people may never have the huge adrenaline rushes that come from large swings in fortune and the buzz of a big win, but they are almost certainly operating in a much more professional manner. As the new 'seat of the pants' operators (known as day traders!) come and go, these people are still booking their profits day by day and month by month. Long after many have quit, they will still be in the pits or in front of their screen, making their deals.
Which is better? That is for the individual to decide. There certainly have been currency, commodity and stock market traders that have made hugely successful bets again and again. Some get out of the market with their profits, whilst others crash and burn.
An excellent but little known example of huge success is the British currency trader and billionaire, Joe Lewis (information here). He rose from obscurity to be one of the wealthiest Britain's and still maintains a relatively low profile.
Huge fortunes can be made, but huge fortunes can be lost too. The real impact of this, often unseen by the many who see trading as glamorous is that a trader can lose everything they own on one position!
This means that successful money management is a key ingredient in the success of a stock market trader. Clearly, this is not something that is picked up instinctively by many. In fact, unless the time is taken to study good money and risk management (information here), most people will learn by trial and error. Learning through experimentation and mistakes can be expensive!
In this regard as well as many others, we would suggest that hubris is a real problem for many new entrants to the markets. By overstating their abilities and / or knowledge or by underestimating the difficulty of making regular profits, many new traders find that they have only managed to learn a few of the vital lessons they need by the time they run out of money.
Any which way you can
Taking the time to study and think deeply about the behaviour of markets, traders and the individual is vital preparation. We recommend that before any financial commitments of this nature that everyone should take the time to really understand themselves and their abilities.
It is this kind of study that over time will lead to insights and higher levels of mastery that bring further insights. For example, there are traders operating from a very wide variety of information sources and models - there are so many that it can be bewildering. There are day traders, NASDAQ traders, oil price traders and even CNN traders following the words of Jim Cramer...
These types of short-term scalpers will not be waiting around for the news from the stock exchange to be delivered in the Wall Street Journal, they are plugged in to the moment-by-moment news coming from NADSAQ and the NYSE. They are watching their Bloomberg terminals closely, trying to see where there may be money waiting to buy so that they can front run a trade for a few moments. For these folks, the NYSE ticker is much more important than the latest pronouncement from Warren Buffett.
A great example of the different level of skill required to really "make it big" is this article about a Japanese trader / legend. It will take five minutes to read, but it quickly becomes clear that he is not like the rest of us normal mortals. Many of the most successful traders, such as George Soros, have a rare mind that operates differently to the rest of us. Add in a hyper competitive nature, deep thought and analysis and very deep pockets and you have a fearsome adversary. That is who might be on the opposite side of our trades!
To the vast majority of humanity (including your author), spending time on such things seems to be pure folly. It is the level of mastery and intense focus and study that has lead these people to develop their day trading strategies and they do not want to see the secrets of stock market traders exposed. Therefore, the successful ones are not bragging about it on bulletin boards or in blog posts, they are making money buying and selling stocks and keeping quiet. Needless to say, any that are prepared to describe their secret formulas are going to want a lot of money for it.
Where to look
In theory, the day trading strategies in use can be used in most countries. After all, many strategies use either highly technical aspects or human nature as their guides - both ought to be global. Despite this, NASDAQ (information here) seems to be ground zero for the day trading world. This is partly because there are high-growth tech firms everywhere on NASDAQ and partly because these firms are more likely to have more volatile prices and be liquid enough to trade into and out of quickly.
That said, there are many people that use smaller companies quoted in London on the FTSE, and commodity prices and currency rates are global. Small cap stocks - otherwise known as penny stocks - are a favourite hunting ground.
The major companies are of course traded in great volume as well. There are many Dow Jones traders out there. The difference though is that day traders are looking for the hot stocks that are going to move today - preferably NOW! DJIA and FTSE 100 companies, the blue chip stocks, do not always fall into that category since they are analysed by hundreds of brokers and everything is known about them (usually...).
This isn't Kansas
Clearly, the world of day trading is a long way from the world of financial planning, income stocks and mutual funds. It takes a certain kind of person and a very specific mentality to be successful as a trader - most of us (as mentioned above) do not have it. If you do have it, a mathematical mind, focus, nerves of steel and a desire to look at lots and lots and lots of charts, then learning about trading could be very lucrative.
It has often been described that the world of day trading is like formula one racing and that the rest of us are in a commuter lane that has somehow found its way next to these race cars. As the cars zip along at breakneck speed, the rest of us are saving for retirement one month at a time in our mutual funds. With a description like that, you ought to know instinctively which group you fit into.
hope that you will spend more time reading this (information here and here) and other information
sites about this subject to aid your progress. We also hope that you
will invest the time, money and effort into using the following
resources to build your knowledge base.
Other pages which may be of interest and relevance to this topic include:
Does The Stock Market Overreact?
Are You An Irrational Investor?
How To Find Great Stock Trading Courses
Stock Trading For Beginners
Why Use Stock Market Programs?
Should You Be Investing In Stock Market Assets?
Does Automated Stock Trading Software Work?