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6 Reasons Trader’s Fail
By David Vallieres, CEO, Strong Market LLC
Let’s face it, trading can be a dangerous business. But so is any business you want to start.
Trading is not a hobby or pastime, it’s a business. And the Bureau of Labor Statistics (BLS) states that only 25% of all businesses last more than 15 years. That means 75% ultimately fail. Trading is no different. There are few traders that started 15 years ago that are still trading.
I started trading full-time in 1987, over 36 years ago, and I’m still trading.
I’d like to share with you what I’ve learned in those 36 years.
The very fist thing you need to discover, before you decide to start trading are the risks, both visible and hidden.
Once you’ve decided trading is the business you’d like to start, then the first step is to identify those risks as well as understand the marvelous opportunity available to you as a trader.
That’s what this website and this article is all about.
So whether you’re brand new to trading or you’ve in the business for a while, I guarantee you’ll get something useful here.
There are 6 major reasons why trading businesses fail:
#1) They have not done their due diligence on the market.
The market for stocks, bonds, commodities, crypto, gold, etc. is international and large, but not all markets are ‘liquid’. A ‘liquid’ market is one that has, generally, a tight bid/ask spread and trades a relatively large number of shares or contracts daily. Some of the largest and most liquid markets are most stocks and financial index futures like those on the S&P 500, the DOW Industrials, the Nasdaq, the Russell 2000, the 10-yr Treasury Notes.
Some relatively illiquid markets include some low-quality crypto’s, penny stocks, and futures such as cotton, pork bellies, coffee and others.
I highly recommend staying away from illiquid markets if you want to be a successful trader.
#2) They have no trading strategy or plan.
The markets are just like a grocery store. There’s so many things to choose from, selection is huge and you should never go to the grocery store hungry or without a list to stick to. And when you go to the check-out to buy something, no one stops you and says, “Are you sure you want to buy those items that are high in saturated fat, sugary, and generally bad for your health?”
The financial markets are like that. No one will stop you from buying anything you want, but that doesn’t mean you should.
There are just some things you should stay away from. I mentioned illiquid markets. Another thing to stay away from are any stocks being touted by talking heads on the major financial news networks, websites or by newsletter. Typically the reason they are being featured is they are being paid to promote the stock or someone is looking to sell a position they are in. I was as my broker’s office in Boston back in the early 1990’s (before the Internet was common place) and, as a customer, you could sit there and watch the market on a ‘ticker’ screen with other clients and place orders at a counter. One day there was a guy that went around to all the traders and offered a suggestion that ‘Microsoft was going to new highs and the time to buy the Oct (expiration) options at a certain strike was now - a guaranteed 10 bagger’. Turns out he was holding a bag of them himself and need to exit, but there were no buyers. He was just getting the traders in the room hyped up and excited about the options so he could exit his position.
It’s much worse today with the huge number of social media sites and people promoting stocks. Everyone talking up a stock or crypto in those rooms has something to profit by opening their mouth about it. Please don’t be naive, they are not being altruistic.
Coming into the the markets without a plan on what you’ll trade, when you’ll trade or how you’ll enter and exit positions is a mistake that can drain your account of money. You need to be immune to the siren’s call of the latest ‘hot’ stock’. If you don’t have any idea how to create a trading plan, you can download a trading plan template I use with my coaching clients here.
#3) They are under-capitalized.
Every business needs money to start. Being under-capitalized is one of the surest ways to fail in any business including a trading business.
Just about every business requires money for raw materials, or labor, general administrative, or working capital. In trading you need money to trade with. That’s your capital base, your ‘raw materials’ that you’ll make profits from, if you will. The goal, of course, is to generate a return on capital (ROC) just like any other business.
You can operate your trading business on a shoestring - that is, you can start with a relatively small amount of capital. In some cases with $2500 or less. But be realistic. The method I developed generates a regular and consistent 8%-21% per month. It’s one of the best in the world. I challenge anyone to find anything that’s more reliable or consistent. But it won’t work miracles. If you start with a $5000 capital base you can anticipate $400 - $1,000 per month in gross profits. Is that enough for you to live on? Probably not, at least for most people. If you have $100,000 in capital to trade with then you’re closer to $8,000 - $21,000 per month in gross profits. That still may not be enough for you to live on, but it’s much better in pure dollar terms but it can also be scaled as you grow your account.
If you don’t have sufficient capital to trade with, it will be difficult to generate the returns you’re probably seeking.
If you don’t have the capital or can’t save or raise it, then there are alternatives such as prop trading. Prop trading allows you to use other peoples money to trade, up to and as much as $10,000,000. However, they are a relatively new phenomenon and I have never needed to use them so have very little experience with them. But I know people who have used them. Essentially you must pass a ‘test’ they provide and if successful they will give you a real-money account to trade with and profits are shared up to 90% in your favor. You can do a search for ‘prop trading firms’ or you can download a list of prop trading firms I put together here.
#4) They are unaware of, or underestimate, the ‘hidden’ risks.
The visible risks are well known in trading. You can lose money trading. Everyone knows this. People can also lose money in any business. People start on average 823,000 business each year in the U.S.. 20% of those businesses, or about 160,000, fail the first year and they can, and do, lose all or most of their money. People can lose money gambling or buying lottery tickets too. People can even lose money working a job by spending more then the make, and living above their means. They can lose money on bad habits.
There are dozens of ways people lose money. Most of the risks are known, but some are hidden.
About 8 years ago I started a hair and skin care company. I private labeled hair and skin care products and sold them worldwide. The margins in that business are enormous. I determined that even if I did not do as well as I expected that the margins alone would allow me to be profitable. What I didn’t know, which seems obvious to me now (but not then), was that the sale of hair and skin care products is ‘celebrity’ driven. Without a celebrity endorsement, I had a very difficult time generating interest and therefore sales. Besides a few sales made in my retail store locally and a few large wholesale orders to Asian markets I didn’t generate as much as I forecast and lost well over $125,000 on that business. The ‘celebrity’ angle was a risk I was unaware of - a hidden risk to me.
In trading, the hidden risks are sometimes not as large as that and relatively minor. One minor risk is losing your Internet connection while in a trade. Having a backup plan is necessary (phone, etc). Losing power during a trade is a risk as well.
Not being able to get out of a trade is risk you may not be aware of. This is potentially true, but rare, in the commodities markets when they go ‘limit up’ or ‘limit down’ in a single day which means if the commodity you bought or sold moves in one direction by a percentage established by the exchange all trading is terminated for the day and possibly for many days as long as there’s an imbalance. If you happen to be on the wrong side of that trade, that’s a risk. Another potential hidden risk is that the financial markets could close if a disaster happens like it did on 9/11. That morning the NYSE and the Nasdaq did not open for trading. The markets remained closed until September 17th - 6 days later. That is a hidden risk, although it’s very rare. Before 9/11, the last time the market was closed that long was during the 1930’s.
#5) Being inflexible.
You should have a trading plan, if not download the one I use with my private clients here. But a trading plan is only a start, not an end. It needs to be flexible enough to change when the market changes. The markets don’t allows trade the same, they change depending on the macro-economic climate and investor sentiment.
To be successful, you need to change with it. The analogy I use often is that the market is like the weather. You need to dress appropriately depending on the season. You generally will not want to wear shorts during a Northeast US winter storm and you probably don’t want to wear a parka in the middle of August in Miami.
#6) Expanding too fast or too slow.
In the trading business you start small and then scale only when you have the resources, experience and confidence that your system will generate superior returns.
Expanding and scaling your trading business too fast will result in large drawdowns and reduced confidence. You want to avoid stretching yourself too thin by being in too many markets at the same time and by trading larger than your account would dictate too fast.
At the same time, you don’t want to stay small for too long a period either. Your plan should be flexible enough to allow for scaling up at a moderate pace by increasing order size, margin utilization, number of contracts or expansion into new markets.
REQUIRED CFTC DISCLAIMER
CFTC RULE 4.41 – HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS SUCH AS THOSE DESCRIBED HEREIN HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY, SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.