Why Do 95% of Retail Traders Lose Money?

It’s exciting, you have just opened your brokerage trading account. Time to play with your hard-earned cash. But wait, have you not heard, 95% of retail traders lose money?

Let me do my best to lay down a few things that I think are worth considering, so that whether you are a retail trader or investor you don’t fall into that 95% majority.

Firstly, what are retail traders?

It’s important to know retail traders are not investors. Investors buy and hold securities (stocks, bonds etc) for several months or years. Retail traders flip a security after a few weeks, days, or even minutes. Both traders and investors have the same aim, to make money.

Let’s make another important assumption about investors for clarity.

Investors don’t buy a stock or something extremely speculative, such as a cryptocurrency, with a large chunk of their total account or portfolio.

Nor do they buy a stock or currency with leverage (more on this point later).

If you consider yourself an investor and put a large chunk of your total cash into a single financial instrument or a leveraged product, then you are among the 95% of retail traders that go on to lose money betting on markets.

I prefer to call this group ‘confused investors’ or ‘opportunistic traders’. If you think you may be either of these, it’s important you address this first before opening a brokerage account.

So now let’s move on to the serious retail traders and investors who want to make an extra living from trading and investing. Firstly, you have to HAVE A GOAL!

HAVING A GOAL

Whether you are a trader or investor, it’s so crucial to have a goal in mind.

That may be something along the lines of wishing to retire with $4 million in 20 years, or wanting to earn $10,000 a month in 5 years so you can quit your job.

Your goals need to be specific.

Whether you hit your goal in the timeframe you set is actually not that relevant. But it is your goal, and you have a duty to see it through.

HAVING A PLAN

For investors, this involves knowing how much you need to contribute each month into your investment account to hit your retirement goal.

To do that I would use a site such as Vanguard Retirement Calculator.

Set the annual expected return to 7.5% which is the S&P 500 Index’s average total return over the last 50 years. Now this should be your base minimum (I’ll explain why in a follow up post and show how you can grow that account quicker by investing in stocks you actually love!)

But what you want to do is make a monthly contribution to start off with for the first few years, and invest it directly. This allows you to average out your contributions through strong and weak markets so that you don’t have to attempt to perfectly time your contributions.

For traders, although the goal is similar to an investor in growing your account by compounding returns, there are a few differences.

Firstly, instead of making monthly contributions, you simply reinvest any profits into the account.

Sadly this means drawing no income from your trading account, until you have reached your goal.

Secondly, for traders, there is more risk at play, and much greater reward.

An experienced day trader can make well in excess of 100% annual returns. A swing trader can have years that are similar but anything close to 3x that of the S&P 500 Index is a conservative place to start if your risk tolerance is low.

Hence starting accounts should be sized according to your experience and risk tolerance. See more below.

DEFINE YOUR INVESTING AND TRADING STYLE

For both investors and traders it is paramount that you define what you are trading and in what timeframe if you don’t want to fall into the category of 95% of retail traders who lose money.

Is it Stocks? Bonds? Crypto? Forex? Emini’s?

Contrary to an investor, very rarely do I meet a serious trader who routinely mixes the above.

A trader has a set process in scanning and creating a watchlist of stocks to trade that week or day. Taking a position in anything else falls well out of the process.

Next, define your timeframe.

If you are a swing trader, you rarely buy a stock at the open and sell the same day.

If you are a day trader, you don’t hold positions overnight. The same goes for taking a swing trading position on anything other than a daily candlestick chart.

DEFINE YOUR RISK

Define your risk for every position. Usually for me, it’s set at 1% of the entire account for trading.

For investments in any individual stock it’s capped at 20%.

Your level of risk could be higher or lower, but define it and stick to it.

This will make inevitable drawdowns easier to swallow. For investors, this really is much easier as the investments have been made in increments.

For example, if you started investing in stocks in 2016, the bear market of 2020 wouldn’t have greatly dented your account.

But for traders 10% to 20% drawdowns are common place (day traders on the much lower end and inexperienced swing traders on the higher end).

Faced with the prospect of such large drawdowns, this can cause many to panic and trade erratically.

New traders especially need to account for this scenario.

So I suggest when opening your first trading account to keep it at the bare minimum for the first few years to minimise the risk of a potential blow up and avoid putting yourself under financial strain.

HAVE PATIENCE AND THE ABILITY TO GRIND IT OUT

If I said to you 95% of crash dieters fail, would that surprise you?

What do these crash dieters have in common with the 95% of retail traders who fail?

I would say the inability and the lack of patience to stick to a long-term goal.

You want to lose that weight quickly and show off that beach bod, in the same way you want to make that quick cash and show it off with a new Rolex and post it on Instagram.

These impulses for instant gratification have to be contained if you want to achieve what you want in life.

There’s a ton of literature and videos on TED Talks on the practice of delayed gratification. It terms of trading and investing, it can be summed up as follows:

1- Identify your goals

It’s prudent you go over your goals frequently to remind yourself of them and stay focused on achieving them.

2- Put in place a contingency plan when you get a large drawdown

This may be as easy as stopping yourself from frequently checking your total profit and loss. Or it could be for a trader to take time off from the markets. Knowing what works for you will likely be a case of trial and error.

3- Remove any temptations

For me this has been the two evils, smartphones and social media. Find what sways you from your goals and remove them, or at least limit them.

4- Reward yourself for sticking to your goals

Results don’t matter in the short term. If you stuck to your plan and process in achieving your trading and investment goals then reward yourself.

Some time off work, a mini vacation, a small treat, watching a movie you enjoy, a spa break, do whatever makes you happy.

By doing so you reward accomplishing small achievements, and when you do that time and time again, achieving that goal becomes easier.

KEEP YOUR INVESTMENT AND TRADING ACCOUNTS SEPARATE

Consider a different brokerage account for each investment and trading style.

I have three brokerage accounts, each of which is solely for day trading, swing trading and long-term investing.

I cannot emphasise the importance of this enough and I may have to give it a blog post of its own!

By doing so, a drawdown in one of the investment accounts will psychologically have less of an effect on your other trading accounts, and vice versa.

I would go as far as saying trading two different timeframes in one trading account is also bad idea.

But, simply put, professional traders keep multiple accounts. Why should you aspire to be any different?!