Mindset

Why Do Traders Fail?

It is widely accepted that most traders are not suucessful. Yet, there is this small group who are consistently profitable year after year. How do they do this? How do they get themselves into this enviable position of being able to make money trading regardless of which direction the markets are moving?

An interesting observation can be made about traders generally either following or not following the rules. It is widely accepted that there are no secrets to what makes a successful trader and the rules that have stood the test of time and do work. Yet most people fail to follow them. Why?

Interestingly, many studies suggest that humans are naturally inclined to fail at trading. People are naturally inclined to break all of the time tested trading rules. Probably the biggest reason for not following the rules is that people generally do not like to lose. Nor can they bring themselves to accept that they are wrong.

As an example, there may be a certain type of person who is very confident in themselves and their own ability at different ventures, and this attitude and confidence naturally carries over to their trading.

This potentially is a problem because there will be many occasions when a trade they enter does not head in the anticipated direction. The time tested rule of ‘cutting your losses’ would be most applicable however for those who have strong self-confidence may find it difficult to close the trade at a loss because doing so acknowledges that they got the trade wrong in their own minds.

This may be a difficult situation to digest so the easier option will often be to not close the trade at a loss and therefore violate probably one of the most important trading rules there are. To most traders, the idea of not closing a trade at a loss means that they haven’t had a loss despite the fact that they may have a large unrealised loss.

Money is something that affects people’s emotions and your natural instincts with money will often encourage you to break some of the time tested risk management rules, for example ‘cutting your losses’ and ‘keeping your trades small’. Most traders focus on making money and realising a loss goes against the aim of making money.

Similarly, when you have a position that is performing strongly, a small part of you wants to sell that position to realise the profit. This is perfectly natural. Letting your profits run and not selling too early is also an important time tested rule, however because of the focus on money, some people can be very quick to sell shares when in a profitable situation.

If you find it difficult to accept an initial small percentage loss in a trade, what makes you think it is going to be easier later on to sell the shares when the position has lost 30% or more? Yet, when you consider the influence of trends in the market and how important it is that you manage risk, the best time to sell the shares is when you are faced with only a small loss.

Thoughts often appear about holding on to shares that are falling in value because one day in the future, they will increase in value and return to the price that you purchased them at. This is unfortunately a myth that many people have about shares in the market.

Some people believe that shares will always return to previous values, presenting them an opportunity to sell them at break even. There is a chance that the share price will never return to the price you bought them at.

Furthermore, whilst you may have absolute confidence that a share price will return to levels that you purchased them at, consider if it is worth holding on to them and waiting for that time to come, if it does. Would it not be better to sell those shares and move on by committing your trading capital into a company whose share price is clearly trending up at the present time?

Often people will think about how they will feel if they sell shares and in 12 months time, the share price returns to where they purchased them. There is a feeling of, ‘I should have just held on to them’. Meanwhile however, over that 12 month period whilst you may have been waiting for the share price to return, your trading capital was elsewhere obtaining solid returns for you.

All of these emotions and others can paralyse you and force you into not making a decision. Remember the old adage that says that taking no action is an action. Successful trading is all about sound decision making and you need to ensure that some of these emotional impulses do not freeze you or cloud your judgement.

The bottom line is that humans are naturally inclined to break the time tested trading rules. If this is the case, then those who do succeed trading are totally committed to their trading and are able to focus on the task at hand. They are able to exercise great internal control and discipline and do as their trading plan would have them do.

If you were to isolate the reasons why people do not follow the rules, you would most likely conclude that it is a lack of discipline and involving too much emotion in the decision making process.