Trading and investing is really quite simple but definitely not easy. There is a saying in the FX industry that “90 % of traders lose 90 % of their capital in 90 days” and I believe this is correct to even slightly optimistic and the statistics could well be worse. Now you could argue that this is only for greedy people who want to get rich quickly and once you are more reasonable that stats should improve considerably. Well, in the 1970s and 1980s Peter Lynch managed the Fidelity Magellan Growth fund with a 10 year or so average return of around 25 % p.a. but a Fidelity study showed that despite the stellar performance of the fund most clients lost money in the fund as they bought into the fund after a significant rise and sold after a severe decline. So this investing business isn’t quite that easy. Let’s see what the main reasons for failure are:
Poor selection criteria
Many investors tend to buy based on a personal opinion, tips, rumour and innuendo or on bad advice often from stockbrokers. Some tips work but most don’t and the investor using tips generally only uses for entry / purchase of a share and never asks the tip giver how to exit the position with either a loss or a profit. Relying on a broker also has its own issues. Having been a stockbroker in my previous life I know the challenges of the job. A broker is basically a salesman and is supposed to push stock to generate commission. Your ‘pushing’ is based on the research of your analysts who have a built in conflict of interest as if they issue a sell recommendation they risk losing access to the company’s management making their analysis more difficult. A broker as such is not necessarily a good trader although some obviously are so it is important not just to rely on a potentially conflicted broker’s advice.
An investor needs a trading system that tells him when to buy a certain stock and how to get out with a profit or a loss. Every system has periods of weakness, of losing money but many investors can’t handle temporary underperformance of the system even if it has overall positive statistical expectancy. They jump from one system to the next, abandon a decent system in a normal drawdown and change to another system that inevitably will soon start a drawdown period. It’s like they are chasing the end of the rainbow, never reaching it, changing style forever. It’s important to choose a system that fits the trader’s personality and thus makes it easier to trade and then stick to it through the inevitable losing periods. Style drift, constant system change doesn’t work!
Don’t cut losses
That’s probably the worst mistake investors make. There is no certainty in trading and investing as we have to guess the future and there is no way we can consistently get it right. Even if as an investor we have consistent selection criteria the market doesn’t always agree with our assessment of a certain investment and it is thus quite normal that some investments don’t work out as anticipated. That’s just part of the game. But many investors are just stubborn, they believe they are right and the market is wrong and they are unwilling to cut losses and keep a position (or even worse average down – throw good money after bad) accumulating ever greater losses. They reason is psychological as we are wired to value the pain of a dollar lost double as high as the joy of a dollar earned. We tend to let losses run out of control and cut profits short as we fear the market will take these profits away from us any moment. This creates a system with negative statistical expectancy and thus negative performance.
No periodic review
Trading is simple but not easy due to the psychological reasons just mentioned. As such it is important to learn from the inevitable trading mistakes making sure not to repeat them over and over again. The trader must conduct regular periodic reviews of his trades and make sure that in all trades he has followed his written trading plan. Only if he follows the plan has he a chance to make it in the markets. During the course of a period review checking out all past trades the trader will come up with better trading rules over time and will thus be able to fine tune the system and improve the system’s performance and his discipline to stick to the rules.
Trading as a hobby
It is so easy to open a trading account and most novices believe trading is easy. You just buy a stock and it has the moral obligation to go up in value just because you bought it, at least that’s what many novices believe. But trading is not easy, it just simple. Trading is a business like any otherand you will have to learn the rules of the game. This will take some time and you need to be serious about it. Just doing it unprepared and treating trading and investing as a sideline, a hobby just won’t cut it. You need to be serious about your development as an investor and put some time and effort into it. It’s a business and you need a business approach and professionalism at first in learning the rules of the game and then in applying those rules consistently. Just doing it when you feel like it, haphazardly, just won’t cut it.
Many traders want too much money, too fast. They are greedy and they want outrageous returns immediately. Well, learning a skill takes time and usually 10,000 hours to training to reach a level of expertise. Trading is a marathon, not a sprint and you’ll learn a skill that will serve you well – eventually – all your life so don’t expect immediate success and outsized returns without putting in some hard work to learn a new skill. Start slowly with preferably no to very low leverage on a small account with real money and increase your trading size over time as you make more consistent returns. Expect to lose some money at the beginning (called tuition fees to the market), break even later on and eventually generate increasing and more consistent returns. Don’t expect to get rich overnight – the universe doesn’t work like this!
You can do it all alone by yourself but this takes time. A good shortcut in your journey to become a good trader and investor is seeking a mentor / teacher who’s done it before you, who helps you shortcutting your learning and teaches you relevant skills and the discipline to apply a trading strategy that has positive expectancy.