The Problem of Trying to Outwit Your Trading Plan

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The Problem of Trying to Outwit Your Trading Plan

One of the greatest problems most traders face can be summarized as “Not following their trading plan or strategy.” As humans beings we have several tendencies which cause this. One of the main culprits is that once we have a plan that works (or at least was shown to work in the past), we try to make it better by guessing which signals will be profitable and which will be losers (because even good trading systems have losing trades). The result is frustration, because our actual trading results end up varying greatly from what the system should be producing. Understanding why this occurs, and more importantly how to change it, is a giant step in becoming a consistently profitable trader.

Outwitting Your System

Once you’ve created a trading plan or strategy–or found one in a book or from another trader–that you like, you’ll want to test it. Through testing it on historical data you find that it was profitable, and would have resulted in a nice weekly or monthly income. You can see that while there were likely more winners than losers, there were still quite a few losing trades over the time frame tested.

In your mind you tell yourself that overall it was profitable, and losing trades happen. Happy with your strategy you open a real money account and proceed to trade. But something weird happens.

In real-time you notice a lot of new information–setups maybe don’t look exactly like they did in simulation or like they did in the past, and so instead of trusting the signal and just taking the trade, you start trying to guess which signals will result in a profit and which will result in a loss.

You have a “great feeling” about a signal, but the price blows through you triggering your stop and resulting in a loss. You have a “bad feeling” about the next trade (and you just lost the one prior, which looked so good!) and so you skip it, only to watch in frustration as it moves in your favor and would have been profitable. Or, you lose three or four trades in a row, and decide not to trade the next day…a day which could have made back all your money and more.

By deviating in this way, a profitable system becomes a completely untested system. While you may have put in the work to test the system, by not instituting it correctly you are not becoming a better trader. Your results are now random, and no longer based on research. In essence you are gambling, because you are no longer trading with the same strategy you tested. By skipping signals, you drastically change the results.

If you want to filter signals, define how you will do it, and then test the system again.

Why We Try to Outwit Our Trading Plan

There are several reasons why we try to outwit our trading systems. One is that in real-time there are likely to be external biases which affect our trading. This may be the opinion of others, articles we read or the news we watch. Typically, don’t listen other’s opinions while trading, it’s a bad idea.

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Also, knowledge is very different than application. Most of us know that daily exercise will make us feel better, but until we actually do it the knowledge alone doesn’t get us in shape. The paradox is that we need to perfectly institute a trading plan in the market to learn how to apply what we know, but we also have a strong tendency to try to outwit our plan when we do.

Another problem is that while you can see the trading system was profitable in the past, or that someone else is a making a fortune with it, those results are not real to YOU. Until you personally experience profitability over a length of time, you simply don’t have the mental belief structure that this trading plan will work. Since you don’t truly believe it can actually work for you, you are especially prone to trying to outwit your system…which has the cyclical effect of causing poor performance which reinforces your lack of belief in your system, which results in worse performance, and so on.

Another big problem is that traders believe trading should be exciting, with big risks and big rewards…but actually all they want is the excitement and big reward. The big risk is simply what allows for the excitement. But trading with a system can actually be quite boring. When trading in real-time with a system there is no outlet for artistic expression–instead you’re just a robot executing a plan (but this actually doesn’t have to be boring; just watching for signals can be quite an involved process depending on strategy). While people say they are fine with following a plan, in actuality their desire to “express” themselves outside of the confines of their plan is a much greater impulse.

Dealing with It

Even if you extensively trade a demo account prior to going to real money trading, you’ll likely experience this phenomenon, even if you were able to trade your system very will well in simulation.

To overcome this issue, find a simple trading system and implement it with a small account and a small amount of capital on each trade (smallest trade size possible). With this account your goal is not to make money. It is simply to follow the plan. You are building discipline as well as your belief that you can actually trade this system. Take every signal, and commit to it, even though it will be extremely uncomfortable.

You may want to scream while doing this and pull your hair out, because following a plan in real-time goes against our biology. Talk to yourself while you trade, reminding yourself that you don’t care about the money at this point. You are working on your discipline and belief structure so that down the road you will be a successful trader. Realize that it will be very hard to do this, and go easy on yourself. Don’t berate yourself.

Don’t tell yourself “I should do this….”. There are no “shoulds”, you simply do.

Trading every signal your trading plan offers will build your discipline, so you are actually able to take your knowledge and apply it. There are no short-cuts. You will be uncomfortable, but commit to following a plan and taking every signal in spite of that discomfort. Over time, if the system is profitable it will help build your belief that the system is profitable and that you can be profitable–this will make executing future signals easier and easier. Until you go through process–and actually do in the market what you are supposed to do and have practiced–you’re simply gambling.

Why Most Traders Lose Money and Why the Market Requires It

Learn why most traders lose money, and why that will always be the case. It’s a systematic requirement of the market. While individuals can break from the herd and make above-average returns, the vast majority of people will continue to buy and sell at the wrong times. Learn from the mistakes of the herd, so you can step into the small group of consistently successful traders.

This article is broken down in sections:

  • How trends and reversals happen, which is systematic of significant losses by the crowd.
  • The social influence factor that shapes the crowd and lures people into the loser’s circle.
  • The numbers game: the best traders continually take the money of the less experienced.
  • How to break from the crowd and become an independent and consistently profitable trader.

Most traders have heard the statistics “95% of traders lose money” or “Only a few percent of traders make a living at it.”

While the numbers vary slightly from study to study, the fact is many traders will lose money and it can’t be avoided. All sorts of reasons are given for the losses, including poor money management, bad timing, or a poor strategy. These factors do play a role in individual trading success…but there is a deeper reason why most people lose.

Most traders will lose regardless of what methods they employ. Even if all traders knew how (keep in mind, knowing and doing are two very different things) to trade successfully based on current conditions, most traders would still lose over the long run. Let’s explore why that is.

Price Extremes Require Nearly Everyone to Get Onboard

To understand why most traders lose, we need to look at how prices move. We also need to consider the large number of people who get involved right when the price is about to turn. This is where the mass losses happen.

When a buying frenzy takes hold in a market, it’s hard to see the movement for what it is: something that will pass! Everything passes. But in the moment, people see other people buying, which makes them think that they if they buy now then other people will buy after them. Anytime you make a speculative purchase, you are doing so because you believe other people will buy after you, pushing the price up which allows you to sell for a profit.

Prices only rise if more people are stepping in to buy than are willing to sell. While we can do all sorts of fancy analysis and make forecasts about price, all we are really doing is making a bet that people will step in to buy or sell. We are analyzing people, because it is people that buy and sell and cause prices to move. And it’s people who cause repeating patterns, that we can trade off of, in the financial markets.

Therefore, an uptrend is created by more and more people continuing to push the price up. A price can’t go up any other way…people need to be willing to pay higher and higher prices. Eventually, there are no more people who are willing to buy at higher prices, or there are more people willing to sell than buy. The people who bought near the top are left holding the losses.

One big problem is that a very large number of people get involved right near the top. For example, a stock has been rising for 2 years and as more people find out about it they start piling in. But there is only a limited number of people who care about that stock and are willing to buy it. Once the masses have piled in, there is no one else to buy and the people who bought earlier in the trend start to sell, which then scares the people who bought late in the trend, and the domino effect begins bringing prices back down.

Let’s look an example: Bitcoin. Bitcoin had been rising steadily between 2020 and 2020, but with not a lot of interest from the general public. Toward the middle of 2020, a lot more people became interested. We can see this by how many people Googled “bitcoin”. We can assume that people searching for information on a product are not experts, but rather want to know more about it. The graph shows that there was an explosion in interest, bringing a whole new batch of buyers into Bitcoin.

People searching “Bitcoin” over time. 100 means peak popularity. Source: Google

Notice how the number of people searching for “bitcoin” coincided with the price of bitcoin peaking. A whole pile of people who had never heard of bitcoin became interested in it, helped fuel the rally, but then popularity hit its critical mass meaning there was no one left to buy. By far, participation was the highest near the top. While savvy investors made money off this buying frenzy, the masses who created the buying frenzy (and the data shows they bought at the top), lost a lot of money.

Avoiding mass losses, and making profits as an individual, will be discussed later on. For now, my point is to show that most people get involved near turning points. Which means most people lose, and are in the fact the catalyst for turning the market the other way. There is a limit to everything, and the mass frenzy causes that limit to be hit.

Along the way up, there will be plenty of people who don’t want to get involved because they believe the price is already too high. But the market keeps ticking higher and so a few of the stragglers join in and buy. Some still hold out and the market keeps ticking higher. Finally, 85% of the population is bullish, and there are still some stragglers…and the market keeps going up. People are proclaiming their achievements and chanting that boom and bust cycles are a thing of the past. Finally, pretty much every person who could conceivably buy is now in…and market plunges the other way.

The chart below shows this in a slightly different way. Since action is more important than talk, when fund managers have almost no cash on hand it means they are “all in” on the market and that means a reversal is likely to occur soon. The problem is that the market does not generally reverse lower until the funds/investors are all in, and it doesn’t move significantly higher until money has been pulled out of the market and most funds/investors are holding lots of cash to reinvest.

Source: Robert Prechter’s April 2020 issue of the Elliott Wave Theorist.

The market is unlikely to reverse to any significant degree until almost everyone is on one side. Which means almost everyone who joined that party late is going to lose. A bunch of people may just decide to wait, but so will the market. And if people are divided, then the market will move in a ranging fashion.

People are the catalyst. Without a large number of people to create an extreme, the market won’t hit an extreme and reverse. In other words, the boom and bust cycles will never end. At least not as long as our markets are a zero-sum game (more on that a little later on).

Attempting to legislate the boom and bust cycles away is nothing more than political pandering. Big uptrends and downtrends are systemic. You don’t have one without the other.

Until almost everyone–who is watching that time frame, and has the ability and interest to trade it–is in the trend, it won’t stop. The trend will keep going, enticing more people in. When it reaches critical mass, which it can’t do without pretty much everyone on board, a reversal occurs.

Unfortunately, the troubles are not over the average person. Not only are most people left holding the bag at the top, they also tend to panic out and sell at market bottoms. Their capitulation selling means there is no one left to sell, so shortly after the price starts rising.

When the outlook is most bleak, because everyone you know is losing money and all you see on TV is how bad the markets are, there is strong incentive to sell and follow the crowd. Once again, the crowd makes a poor decision, which it can’t help doing, and the market turns the other way.

The examples are just meant to show that most people lose by acting in mass at the same time. The masses can’t avoid it, because it is there action that exhausts the trend and reverses it.

Even though a long-term chart of the stock market shows the price of stocks rising, remember that most of the people are flushed out because they are buying near peaks and selling near bottoms. Also, those long-term charts of the stock market, like the S&P 500 index, don’t include the stocks that have gone bankrupt or fallen on hard times. The S&P 500 only includes top companies. If a company begins losing money, it is dropped from the index and therefore has no negative effect on it. But of course that stock still exists and if it performs poorly people will lose money.

Why Most Traders Lose Money – Social Influence

Successful traders find something that works and stick to it, not letting others pull them away from their strategy. This is where unsuccessful traders go wrong and why the crowd loses money. Despite most people’s best efforts, they can’t pull themselves away from the crowd when it really counts.

When all you hear from your friends and the media is how good this asset is doing, or how bad that asset is doing, it’s hard to take a contrarian view. As humans, we tend to default to availability bias, which is believing what we hear most often.

If you make a bet against everyone else and you are wrong, your friends laugh at you or you feel sheepish. You experience regret for missing out while others profit (even if only temporarily).

There is a social cost to not being part of the crowd. You can’t talk about trades with others, or you need to tread carefully because most people will not hold your view. If you do take an opposite view to the crowd, and you are right, people may hate you because you made money while they lost their shirt. Sound ridiculous?

Consider the public uproar during the Occupy Wall Street protests, or people feeling great resentment for the hedge funds and traders that made billions by seeing the housing price collapse and taking advantage of it! Or the manager who is resented for keeping his job while several of his employees are laid off.

Winning traders are often “crucified” during major market turns when the majority lose. People prefer like-minded company, even if they chat their way all the way to the poor house.

I remember I had a number of radio interviews scheduled in 2008 to discuss winning strategies and profiting from declining prices. The interviews were canceled because the hosts and producers thought talking about making money during a stock market crash was too inflammatory of a topic!

It is very easy to say “I will follow the crowd and get out before them.” Following through on that is quite difficult…which is why crowds move together. Everyone in the crowd thinks that. Also, if you understand bid and ask prices, once people start to sell there are only so many shares are each price level, and so if you want to get out you need to sell to a lower bid price, then a lower one, then a lower one. Everyone can’t get out at a good price…only the quickest and most experienced typically get out before real damage is done.

Everyone sets out to be an individual and trade their own way, and by doing so most end up being with the crowd that loses money. Why? Because each person lets it happen..unwittingly. Their social mood–whether it be optimism, greed, fear, etc.–is likely being fueled by the same social mood prevalent in society. It is no mistake that individuals begin to like the same sorts of fashions that everyone is wearing.

In a quest to change, the majority of society ends up changing together, moving towards similar desires and away from similar dislikes. Therefore, what the market is offering provides the exact thing that will lure the trader into the crowd.

Think about why the spike in bitcoin was so alluring? People thought they were acting responsibly by buying into a new technology that would change the world, just like in the Dotcom bubble. They thought $15,000 to $20,000 per coin was cheap because it would rapidly ascend to $100,000. Such ideas were common in the media at the time. The information that made people think they were making a great trade was being fed to them by the crowd who believed the same thing. Many of these people were not acting independently, even though they thought they were. They all joined forces, herded, and pushed the price up. But no one stepped in after them and the price dropped below $7,000. While the price may go up or down in the future, that doesn’t change the fact that the biggest number of people were lured in close to the top, and will sell near a bottom.

No matter what the market is, once something gets very hot or cold we are more likely to see and hear about it from our friends, through ads, and on the news. In this environment there will be lots of “helping hands” to welcome us into the crowd, teach us to be a part of the crowd, and initiate us into the world of the blind leading the blind.

Why Most Traders Lose Money – A Numbers Game

Financial commentators will make statements such as “Most professional money managers can’t beat the S&P 500 benchmark.” True. But it is not the professional money manager showing their ignorance, it is these critics who understand nothing about market movements.

Most market movement is created by professional money managers who are managing trillions of dollars in assets, and also by other professionals/businesses who need to transact or hedge risks to carry out their business. Therefore, if the market is up 10% in a year, it is because these professional fund managers have on average bought the market up 10%. Therefore, it is impossible for most professional money managers to make more than 10% that year, because it would be equivalent to asking someone to beat them self at a game of tennis.

Returns will be spread out from negative returns to triple-digit returns, but on average they will have made about 10%, minus a management fee and expenses which means most fund managers will underperform. If the market is up 10%, the average hedge-fund return may be in the ballpark of 8 to 9% after fees, possibly lower.

The majority of investors and traders will not beat the benchmark because they themselves create and are a part of that benchmark!

What is really interesting is that while a great hedge fund may make an average of 20%/year over the last 20 years, the average investor in that fund has a high probability of making far less than that. Why? Because they invest and pull out their funds at the wrong points, just like they do in the market. The hedge fund or mutual fund is a (micro) market, where investors/traders can deposit and withdraw based on how they think the fund will do.

Certain traders do manage to outperform consistently. Many other traders and novice investors come to the markets with a handful of bills and then lose it. There is a steady and continuous stream of these people. They feed the kitties of those traders that are successful. Also, the very fact that so many people pile into (out of) market tops (bottoms) means there are favorable opportunities for those that can keep an objective eye on the market.

In order for the glory stories to happen–such as traders making a 100%.. 500%…2000% returns (whether in one day, one year or several years)–how many traders must lose their shirt (or give up profits) for that to happen? Lots! Look at it a different way. That day trader that made $6,000,000 last year got that money from somewhere. Since small retail traders compose most of the total number of traders (high in number, small in worth compared to professionals) it was likely that $6,000,000 was taken right from those retail traders several thousand dollars at a time.

For a day trader to make $6,000,000 in a year, that means about 120 people lost $50,000 each and/or gave up $50,000 each in potential profit! Or 1200 people lost $5,000. This is a simplified example, but it does provide a perspective not often considered. In order for someone to win, someone else must lose or give up profit.

The big returns that lure people in droves to the markets are ironically what create big returns for others and losses to the droves.

As Individuals Apart From the Crowd

The crowd is not a crowd until most are involved.

Crowds can’t create strong trends until most are involved.

A trend won’t stop until nearly everyone is on board with the crowd.

When everyone is on board, it reverses.

Since the crowd can’t win, that means only a small percentage of individuals can.

While this article provides a broad context, it applies to the small scale as well. Day traders get caught in the same crowd behavior without knowing it. That rising stock they watch all morning before finally jumping in, only to have it move the other way, is the same phenomenon on a smaller scale. On a 1-minute chart when the uptrend reverses, there is no out there at that moment who wants to buy, and so the price reverses.

Buyers and sellers can get exhausted or elated on all time frames. They experience short and/or long bursts of emotion which result in short and long-term actions/reactions, all leading to patterns which are visible on all time frames. There are are also degrees of bullishness and bearishness across time frames, meaning at times the trends and reversals will be aggressive and at other times more sedate depending on how many traders (and the public) are involved.

The bottom line is that traders must stick to a well-defined plan and trade that plan even when it is uncomfortable. The vast majority of the population, and thus the vast majority of traders, buckle under this uncomfortable pressure…the same way we reach for the chocolate bar instead of the carrots.

Since most of the population is more than happy to join the crowd, by having discipline combined with a decent strategy it is possible to be one of the few successful traders who doesn’t take part in the crowd’s losing ways. Day traders, swing traders, and investors can make great returns, but only if they adhere to a few concepts.

If you don’t know what you are doing, buy an index fund and hold onto it. Don’t try to trade. Over many years the market tends to rise, so this is a good approach for someone with little experience or time to learn how to trade properly. It sounds so simple, and yet the vast majority of people get spooked or euphoric and buy or sell it at the wrong time, thus messing up the long-term returns.

For those who actively want to trade, don’t be lured into the crowd. Think independently, which means doing your own research. Look at charts and see how prices reacted to different events and price patterns. Develop or learn strategies for taking advantage of common price patterns. You don’t need to be right all the time, even if a pattern only works out 50% of the time, but you make more on winners than you lose on losers, that is a winning pattern.

In making your own trades based on your own research and strategies you will sometimes be aligned with the crowd, and sometimes you won’t. But it doesn’t matter. You’re trading your own game, based on statistics you know and trust from doing your research and testing your strategy.

Once you have a method, turn off the TV, forums, and other’s opinions of the market. Their opinion is based on their strategy (if they have one!), not yours. You have done the work on your own strategies, so trust them.

Everyone comes to trading saying they are going to be better than everyone else, or that they just want a little taste of the profits and they will be happy. But to make money consistently means you need be in the top few percent in the world. Being in the top few percent of anything isn’t easy. But it can actually be as simple as buying and holding an index fund for a slow accumulation of profits. That will put you ahead of a lot of hedge fund investors. Or, if you want higher returns which are certainly possible, it involves developing or learning strategies and then putting them into practice more actively (see above).

Trading is a process of continual discipline. We are only as good as our discipline. We can be a great trader one day, and piss poor the next if we stop following our plan. Many people think that once they become profitable they can relax. Do you see professional athletes ease off once they make it to the NBA, NHL or the PGA? No, they continue to work hard at what they do…or they fall by the wayside.

The ones who last enjoy it. They enjoy the challenge and the competition. Those who love trading will put in hours without evening thinking about it. Those who only trade to make a quick buck will never be able to compete with the person who loves it and immerses themself in the process of learning and improving. Only trade if you really want to. Without that passion you are at a huge disadvantage to the people who have it.

Good luck on the journey. While I think it’s important to explain things so people know what they are getting into, I am of course a trader myself. I started trading full time in 2005, love it, and don’t want to do anything else. I put in a lot of time to become profitable, and still put in a lot of time to maintain that performance and try to improve. I do believe that anyone with time, dedication, and some capital can be successful at trading. While most people will lose, as individuals we have a choice as to how hard we will work. There is lots of capital out there floating around, which we can learn to grab, but it won’t happen by continually doing what the crowd does.

By Cory Mitchell, CMT @corymitc

If you are interested in learning how to trade the stock market, whether prices rise or fall, check out my Stock Market Swing Trading Course. I guide you through 17 videos and more than 12 hours of instruction on how to swing trade stocks effectively and efficiently. Download and learn at your own pace.

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77 thoughts on “ Why Most Traders Lose Money and Why the Market Requires It ”

I have a mathematical question, if 95% people lose money, why they are in the market? it seem illogical to me.

This is addressed in the article.

As they lose money, they are no longer in the market. They stop trading (or they continue to dabble and lose money off and on over the years), leaving those that are profitable. There is always a fresh batch of blood entering the market, and most will lose, feeding the successful traders. New traders pile in and unsuccessful ones pile out. It’s a revolving door, except for the small percent that find success. Why this happens is discussed in the article, as well as ways to avoid it. Anyone can be successful at trading, but it takes a lot of work and practice, which very few people expect or want to believe.

The number may seem illogical because of survivorship bias. The people you see trading (or talking about it) have survived. But we need to remember all those people who tried trading, but then lost and closed their accounts…and don’t talk about it. Nearly every friend and family member I know, and friends of friends, etc, have tried trading…how many are making money consistently? Very very very few.
Most exit the market, or if they are smart they start researching a lot more and create a profitable plan, or if they don’t have time to do that they just buy and hold index funds and never look at them. The latter two options will put the person in the winner’s column.

Vert interesting and thought provoking article. It is kind of scary that when I am making money someone is losing it. I know it should work like that, but I don’t think about this when I trade. Maybe I should think about it more often.

But if you loose someone is gaining your money.

Excellent article! On point and very good organized analysis! You should consider submitting this as a white paper to magazine.

I have a friend that knows someone who sold his house and bought bitcoin at $16,000.

This article, coupled with the comments, is possibly one of the best discussions I have come across on the internet. As a day trader with five years experience (as I enter my sixth this year) I concur with many of the views here. Technically, I don’t think chart reading or reading of the crowd is that impossible, but, as others have stated, it is the mental mind control which is the real heart of the matter.

Get that under control and the riches of the garden of Babylon will be yours. Although I am up 585% on my initial capital since I started, every day is a struggle to consistently keep the mind under control, but also to correctly call turning points on a live chart when taking into account areas of resistance on a yearly chart.

One thing I have noticed (more) recently is as the market nears areas where the probability of a change of direction becomes significant prices aren’t always obtainable which may indicate our markets are now more infected with algo’s than they have previously been. This may be just a hyper vigilance on my part as to the length of time I have been doing it, so that is something to take into consideration I suppose.

Cheers from the UK.

Interesting comment about “every day is a struggle”…I said almost the exact to someone the other day. The person’s question and my response are below.

Question via email: I was just wondering why do you think the success rate among Fx traders is so low? Do you think it’s because most people don’t have enough time on their hands or haven’t practiced enough?

My response: It’s both those things.

Mainly, it takes longer than anyone expects. Which is why you have to do it because you want to, not for money. When I started and wasn’t making money for 5 or 6 months, I could care less. I was absolutely giddy to get up and trade. I would have eaten Mr. Noodles for the rest of my life, I didn’t care. I just wanted to do it. That is probably one reason why I do well at it.

The practice is the same thing. I am honing my skill all day everyday, but it never feels like it because I just want to do it.

It also about admitting that it isn’t easy. There is no destination. I have never been able to relax and say “I got this now.” It is hard and it takes work, discipline, and focus every day. There is no letting up or letting your guard down, because as soon as that happens another trader will come along and take your money. It’s relentless, and a lot of people can’t handle that. They think that if they put in a bit of time it will become easy. It doesn’t. It is always work, and the market will also try to fool you or cause you to question yourself. That is what I love about…it always keeps you on your toes. People either love that aspect and embrace it, or they go broke.

[I will add that certain things definitely get easier. I don’t have to question my methods anymore, and I know how to handle my emotions, most of the time, when I hit a rough patch. But you can still never let your guard down…even after doing this for about 14 years. Every single trade, and more importantly the time between trades spent staring at charts, is an exercise in discipline to follow a method and not deviate (which my mind still wants to do all the time, but I control it).

And that brings up another point, which was not in my response above. People have an action bias. They want to trade, and so they look for trading opportunities. But successful trading is as much about NOT trading as it is about trading. I only day trade (watch my charts) for about 2 hours per day, that’s about 7200 seconds. Out of those 7200 seconds, my fingers may actually hit my buy and/or sell keys 8 to 20 times. That means actually activity for only 20 seconds out of 7200. THAT is the hard part, controlling yourself to execute only at the VERY few seconds of the trading day where there is a decided edge based on your strategies. For the other 7180 seconds I am left to plan my next move and analyze the market so I am ready to pounce when my next 1-second of physical trading action occurs. I use the time between trades to strategize upcoming trades, rehearse them in my head, run through various scenarios that could develop once I am in the trade and how I will handle them. Not many people do that, which could be another contributor to the low success rate. Just like in chess, the victory goes to the person who uses the moments in between moves to strategize further ahead. ]

That’s a nice reply.

Perhaps I should expand a little; when I say “every day is a struggle”, that’s not completely correct it’s the focus coupled with market action on the day. I’ve been long periods where I have done well, but on occasions I let my guard down by having a ‘bias’ (or a view if you will) about how a particular stock should react to a piece of news or level and don’t hit sell or buy quick enough. I.e. for me personally I think it will take at least another two years to find that consistently which I do have for periods, but then, once in a while I ‘ll make a mistake i.e. finishing the day down somewhere between 0.5 – 1% plus on the day. Then I am unduly hard on myself hence the ‘everyday’ is a struggle comment. It’s just about boxing the mistake up and thinking clearly for the next day.

One of the best comment’s I ever read was something along the lines that goes like this; “The market is always telling you something but it’s whether you are listening clearly enough to hear it is saying is the hard part.”

Cheers again. (Just for info I am a day trader of shares and not FX.)

Every day must by default be a fight of mental control. Props friend I’m entering my second year and it’s been bumpy to realize this but now I’m back up at 25% again.

Algorithms, dark pools and stock manipulation. Things the average trader never sees.

Its like central banks sucking out liquidity from the markets. The people who run casinos (stock market) are forming (indirectly) government. Money is just their consent. Whatever they sign (now digitally) becomes money. To make the system perpetual, sometimes the lose willingly (bull market) which doesn’t harm them (consent is without bounds). This is a different perspective.

This article is spot on, alot of people like to dabble in the market, and they lose because of lack of knowledge, and in financial trading what you dont know WILL hurt you, I have personally been part of the 95% of the losing traders in my first year of trading in 2020 and lost alot of money because I was naive and didnt follow my strategy correctly everytime and had bad risk managment and also unrealistic expectations. Forex trading to me needs someone who is emotionally balanced, resilient towards risk (you must be able to deal with losses at times) and keep a clear head even in your winners, dedicate yourself towards educating and improving your edge in trading. I have since become part of the 5% of winning traders and making consistent returns of 5 figures atleast every month eventually because I never really gave up. In conclusion trading is not really for everyone, but if you can stay committed, get a mentor, keep yourself motivated, read self-development books and believe in yourself and you can surely make it in the FX market. My advice, Dont rush to open a Live Account like I did because I was rushing to make money. Focus on making yourself a skilled trader, paper trade, dont underestimate demo trading, practice until you see that you can now consistently make profits month-to-month. Once you have the skill, money will naturally flow in your trading account – and personal bank account! Sometimes You dont need money to make money – you need a SKILL

Unfortunately the statement here is non-specific and gives no strategy on how to do anything. The only take away I get is avoid the herd mentality by:
1) selling in a bull market
2) buying in a bear market

Trevor — would you be willing to email with me a little? I am a fledgling ForEx trader who is quickly dying on the proverbial vine and I need some help and assistance. If you are willing, PLEASE please email me at: [email protected]

Cory well said and written about why most traders lose money. I am not a trader yet but really fascinated and challenged that there is money to be made in trading. The object of trading is to make money right? But why with all these gurus and technological presentations etc still I believe missing the point except of what I read from you. You hit the right button. I am 68 years retired and made most of my money following a simple rule other than my 3 pensions. My simple rule in making money is BUY WHOLESALE AND SELL RETAIL. it seems to me based on your article 99 % of retail and individual traders were doing the opposite without knowing it as you explained. THEY BUY RETAIL AND SELL WHOLESALE. That’s Insane. Show me strategy when to buy wholesale and sell retail in trading with everything factored in, I can make a living or earn an extra income for life. Just a little chunk of profit here and there with minimum loss (exiting when the direction didn’t move as I expected). I am just a simple and uncomplicated minded person. Sure will enjoyed more if I had known trading 20 years ago. It’s never too late to teach an old dog a new trick as they say. Happy new year and a Happy profitable trading to all.

i’ve made lots of money. i am scared all most of all the time. i can’t give it up. i need the money and i love the thrill of the roller coast ride too

I stumbled onto this page while looking for a figure as to what percent of the investing population trades Futures, for a book I am writing. No luck finding that number, but I do sometimes like reading articles that people post about making money trading. Usually I find humor in the comments of false prophets suggesting they can show you how to make money.

I started reading your article and have to say kudos to you for speaking honestly. Friends ask me regularly how to make money, and I always inform them not even to try. Just invest, watch your tax efficiency, as expenses and gains are one and the same, and over time hope for the best.

One thing I do disagree with though is your comment on statistical aberrations. It is incorrect as a function of the time interval you are using being 1 year intervals. An active professional trader can be reviewed each year on performance of 250 intervals, average and standard deviation. When I think of my personal trading performance, that is how I always saw it, what percent of DAYS I traded positively. Over my career that gives me several thousand data points.

Two other comments I might make for anyone that still wants to play this game, a game I no longer play myself.

Rule 1 – (of my 97 rule number 1’s) – A great trader is not someone who sees the future correctly, it is someone who manages their risk correctly. If you are playing a game that is essentially 50/50 and you take your profits quickly and let your losses run. You are now creating an unequal distribution of scale between your winners and losers, and you are dead before you start, time will finish you quickly. This takes a serious emotional control, one almost requiring a sociopaths personality.

2- Some people really are just spectacular traders – thinking you can play against these people is the equivalent of me thinking I can line up at Right Offensive Tackle against a 300lb Defensive End. The final outcome is not going to be good. The more sophisticated the product – think options – the worse your disadvantage gets. No one reading this should ever trade options.

Once again, Kudos to you for your honesty. It’s rare.

“No one reading this should ever trade options”

Options are both far easier and far more difficult to trade. When structured correctly, a profitable trade can be had while being wrong on direction, timing, and volatility direction, the three main components of option pricing.

In short, just because YOU can’t do it, don’t cast your blanket of dispersion on everyone. I do it successfully as a retail trader. It can be done. It’s just damn hard to figure it out.

With all the generosity of my heart, I wish you the best. I didn’t know I had auto-reply on, so I received your comment today in my e-mail. I will stand by what I said and inform you it is coming from someone who started their career at a boutique derivative firm and went on to hold title as head of trading at three of the largest trading firms in the world. My core competency is non-linear derivatives and synthetic structuring, and I pretty much liked to trade in 1,000 lot clips, but thought nothing of taking down 10 to 50 thousand at a time, and have carried into expiration strike risk of over 200,000 on several occasions, which is rather insane, even by my standards. I was also a member of the NYMEX, COMEX, AMEX, CBOT, CBOE, and CME before I turned 27. I retired by the age of 34 because I burned out completely and just couldn’t do it anymore. I also never had a losing month in my career as arbitrage removed the variability that I am sure you see attempting to trade options directionally.
I do wish you well though.

Which is more risky…. Owning stock or doing a covered call? Hint: The answer is owning stock. Does owning stock give you a chance to make money if the stock goes no where? Does owning stock let you define how much money you could lose (without stop orders)? Does owning stock in any way let you know how much profit to expect? Does owning stock let you profit when you are wrong directionally? As you can tell, it’s my opinion that options trading, when done correctly, is one of the best ways to -avoid- risky trades.

Hey again Cory,
I just re read this article and it really does ring true with me. I am trying to understand why everyone here in the U.K. is so shocked at Trumps win.
Investment analysts across the board are all scratching their heads saying ‘no one saw this coming’ WTF? The excuse is that all the polls and press had it in the can for Hillary.
It just reinforces that the markets ARE an extension of people as a mass. This insight may help me to understand how the market is more likely to behave, do you use that model or do you track back from mainstream thinking to market behaviour, which way round do you assess?

This is tough question, because it changes. Much of the time it is good to follow the herd to a certain extent. I am a trend trader mostly, so when things are going up I am a buyer (only on pullbacks though).

But there does come a point when that sentiment becomes too strong. If a trend has been going up and up and up, eventually everyone starts to take it for granted. By that point nearly everyone who wants to buy, has. With no buyers left, the price starts moving down.

Or we also see sentiment extremes on the downside. As oil was falling earlier this year and last it was profitable to bet on the decline. But once you start reading the mainstream media talking about the disappearance of oil, and nearly everyone you talk to saying oil is finished, that is typically when I start buying (I also started buying because we were near 2009 lows in oil…another bad time in history but oil rallied aggressively off those lows).

So I look at sentiment a little bit, but typically you can just see it by looking at long-term charts (for investments). You see long-term areas where the price has topped out (sentiment too bullish) or bottomed out (sentiment too bearish). In between I typically don’t invest…I just look to buy investments when everyone else hates them…but that history dictates is a good time to buy. (Sometimes adjustments need to be made for inflation, company growth, etc)

Shorter-term trading is really the same thing, but typically that I am not looking or thinking about sentiment at all. I am just trading trends and taking trades based on favorable reward:risk ratios and making assessments of whether the trend is likely to continue or not (based on recent price action…which gives an idea of whether buyers or sellers are likely to be stronger in over the short-term).

So mostly I rely on my charts, but for investment purposes when I start to hear a lot of extremely biased proclamations on the market, I usually start trading in the opposite direction of such claims.

Hi Cory,
Thank you for such a thoughtful response, it’s really helpful. Also a great new post today from you, I wish I was already set up for daytrading to take advantage of your insights!

Hi Cory, Nice article. You said, “In my opinion, there were some major advances in technology during that time which could potentially do a lot of good, and thus the rise was warranted. Unfortunately, we have mostly squandered that potential good on primarily creating products and services which decrease productivity instead of increased it; products which provide us an escape from the real world as opposed to help us harness the real world.” I’m curious what those “escape” products are? I’m guessing video games… not sure.

what a depressing article. just what i needed…

Or liberating. Each person can forge their own path. Just depends on how you look at it.

an article telling you have basically ZERO chance of making $ can NOT be liberating sorry… not more than the motto written on the gates of a concentration camp (“work makes you free”).. unless, of course, you have a different definition for that word.

censoring those who disagree, and leaving only positive comments, eh?

maybe its depressing because the points the article is making about how traders loose to the markets hit sensitive points within you. maybe you just don’t want to do the work to investigate these points so become a better trader. how do you think it happens . you wake up one morning and you’re a great trader . no . it takes your work. most traders have an idea of wht they think the markets are. they romanticize it so they can be the winner. but reality hits and the market doesn’t care what a trader thinks. its being the market 100% and if you want to capture profits. get in the flow of the markets.

This is such a great article and the comments and your replies are worthy of a post in themselves, perhaps you could elaborate on the theme in your reply to Abhi’s question, there are some real gems there to be polished!

The whole article has really got me thinking. I have been seriously following investment blogs and websites for a few years now as I find it an intriguing subject matter which straddles many other subjects including behavioural and group psychology and social anthropology (which was actually my subject at university).

There are some incredibly bright and interesting people talking and writing about this field and I love to follow these intelligent guys, I wish I could meet them too and listen! I also enjoy podcasts, which I would love to hear, if you have one.

But, strangely, I am not actually invested in the market as yet. Ha! I may be a late straggler and lose everything! I am enjoying the debate and insight and often philosophical humour that prevails in the articles, there is a depth in this field which is difficult to find in political, economic or business blogs/writing. I’m in it for the wisdom, philosophy and humour and the personalities of the people behind the blogs.

Having said that, naturally I would consider investing and I have a number of fantasy accounts to play with strategies. I have friends who day trade but I would not previously have considered that as a viable way to earn income. But on reading this article, I am thinking day trading would be a very rapid way to learn the reality of trading and the stock market. I feel bad for commenters Fab and Sarbinson’s accounts of their losses after decades in the market. Would day trading be a kind of microcosmic method of learning about how markets work and how to best read them and work in them for a profit?

Thanks for the feedback. Yes, day trading is like the microcosm of investing. It will show how prices move. Typically patterns that play when day trading also play out over longer time frames as well. While my investing strategies are different than my day trading method, they are based on similar concepts.
If the ultimate goal is to just invest, then learning to day trade–which takes considerable time and effort–seems kind of pointless. Better off just to focus on learning how to invest. But if day trading is the goal, then by all means focus on that.
Whether day trade, swing trading or investing a person only needs to learn one strategy that works for them in order to make money. All other knowledge is excessive, and not required for making money…but may be accumulated for the sake of interest, or to sound intelligent in conversation ��

Gud Evng Every One,

Mr. Cory Mitchell Sir,

it’s v.insightful & inspiring article, its cutting the noise and provides smart ideas.Thnx
kudos to u,for detailed explanations,its v. rare .

My name is Amit,a independent research student and r&d pro from India, Apart from research and work i am having passion in Investment Management, Applied Behavioral Finance & Analytics,Behavioral Science for Investing.writing,reading,learning new things etc

i want to utilize my research:analytical,due diligence,attention for detail skills for doing investment analysis and do research based trading aswell,but after reading ur article now i want to adjust the focus

i have 1 question in 2 parts-

a) sum people says “MIMIC ‘ACTIVIST’ INVESTOR’S MOVES”,what ur take on this idea?
b) whr to find the (activist’s) foot prints,in India as well?

Thank you for your time and consideration.

Leadership is not about ur title,it’s about ur behavior : A Wise Man

a) “MIMIC ‘ACTIVIST’ INVESTOR’S MOVES”,what ur take on this idea? People can do this. But ultimately they still need to follow what the successful trader is doing. This is quite hard. It is no different than just following a winning strategy (following a strategy or a person are the same thing). Most people can’t do it, and end up deviating. So basically no matter what approach you take to the market, assuming it can theoretically produce profits, the ultimate success of that plan relies on the individual’s ability to follow the plan. If you follow what a winning trader does, exactly, you should be profitable. Yet few who take this approach are…see video at end of article.

b) I do not know the successful traders in india, nor do I follow much about the Indian stock market, so I can’t offer any guidance there.

Great article. Now the even greater irony. Even without reading the comments above I would imagine the overwhelming majority of such commenters will indicate they totally understand what makes a trader successful.

Cory– Thank you very much for your insightful analysis! The more I use behavioral analysis in my investing, the more successful it becomes. –Steve

In the end, it’s all about identifying the kind of market your trading in and recognizing it when it shifts to a different type of market and being able to change strategies that work given the market you’re trading in. To get to that point, you have to have inherent, God given traits of perception, patience, intellectual capacity and nerve and years of experience. Most don’t have the innate ability and those that do, usually lack the staying power. That’s why there’s so few who are truly profitable.

This is a great article. People are so obsessed with numbers they forget the market is entirely psychological and largely qualitative and it’s why I find markets fascinating. I realized the keep up with the Jones’s thing ends in doom every time if you stick on that too long. Sell sell sell buy miners.

Hi everyone, I keep studying and learning and trying different strategy but none really seems to work I have done courses read books and still I can t find anything that really give me an hedge, so I start wondering do they really exist? a profitable strategy? I have done long term trading( holding up to 6 month) for 2 years and did well 30% average return per year, I have been day trading for 1 year I m down 10%

That is a respectable day trading return in your first year. Many people lose all their capital in the first year of day trading. You are likely doing some things right, it is just a matter of continuing to fine tune your approach. Look through your trades, and spot areas you could improve. For example, is there a way to make your losses slightly smaller? Does the price tend to run a bit further after you get out? If it does you could seeks to expand your profits slightly. Very minor changes over many trades can take you from being a losing trader to a consistently profitable…but it takes constant monitoring and adjusting to current market conditions.

Your other option is to stick to longer term trading, as that seemed to do well for you ��

thank you, yes many times I get out and price keep going up I went from 70% winner to 70% loser since i m studying technical analyses

Thank you for the insightful information

In other words the Market is a lagging, not a leading indicatOR.

In what way? The market operates as a leading indicator for the economy.

There are times where there seems to be a disconnect though…. and we will shall see if it continues to act as a leading indicator in the future as more and more central banks interfere with the market. But markets (more accurately: traders and investors) buy/sell based on what is expected in the future, which means markets move in anticipation (lead), and then based on the trader’s conditioning/beliefs they buy/sell based on what they think will happen next, and so on.

Very insightful article. Indeed market is irrational. Oil went up yesterday when it seem that oversupply is still rampant in the market. Lost money by betting against it! =/

Losing trades happen. That is part of trading. But believing oil will fall because of oversupply on a particular day is not a prudent strategy. Oil has been rising for weeks in spite of oversupply. Successful traders trade off things they have tested and that have proven to reliable over and over again. Also, oversupply was the reason for the decline that took oil below $30 in the first place. That information was already priced in. It’s old news. Almost everybody was on-board with that idea, and that is why oil fell so much. But as the article states, when everyone is on-board the trend can’t continue. Oil prices had to go up (in the Canadian Investing Newsletter I have been buying commodity stocks since January). Markets move ahead of the news. They started dropping as oversupply became a potential problem, and then fell heavily when it started getting some publicity. But markets are forward thinking…so the price rises in anticipation of supply eventually dwindling because some oil companies will go bankrupt and as oil producing countries get squeezed financially there is an increased chance of conflict which would further increase oil prices. The drop was priced in, everyone was onboard, which means there was no one left to keep pushing the price lower….so it had to go up. As it pushes up, everyone who sold at the bottom is forced to buy and get out of their losing positions, pushing the price up further.

Ultimately though, none of this matters. Study the charts and find patterns that work over and over again. They are there. Then don’t let the news of the day distract you. Trade the pattern when it occurs, and you will find greater success in the markets.

Hi mitchell, I have created a simulation chart based on random numbers, resultant chart look very similar to our real market charts, there will be trends small, major and all kind of, now seeing that trends also form in randomized charts and today most trading happen by algo hft machines, which are not following trends in most cases rather selling buy to capture the spread, so it confuses me whether the trend formation happen due to conviction of many tradors or some other reason behind it.

Great point and question Abhi. I think your question relates to the fact that something appearing similar is different than cause and effect. Let me explain.
If you go into a casino, you can track whether the roulette ball falls on black or red, or if baccarat hands come up player or banker. If you chart this, you will see trending periods, as well as choppy periods. It will look like a stock chart. Yet we know that the results of the ball falling on red or black or the cards dealt in baccarat are random (assuming fair play).

So you have a good question…if the random charts generated above look like stock charts…are stock charts actually random? I say no. What creates the random charts above can’t be controlled or impacted by the players in the game. Yet with a stock chart, the players do impact what happens on that chart. I can buy and buy and buy, causing an uptrend. But in the casino it doesn’t matter what I do, the cards are already determined. So while your random charts may look like a stock chart, the cause and effect are different.

Stock charts may appear random, but the underlying driver is fear and greed. On a random chart (or in the casino), fear and greed can’t affect the outcome of the cards or spin. Stock movements are created by thousands or people (or few) buying and selling based on their future expectations, but then reacting as their expectations come to fruition or not. While I have never tried, it, I doubt the strategies I use would work on random data. They work on real markets because there are moments when you know emotion will kick in, and the market (other people) will react in a very specific and predictable way.

I do view markets as random much of the time though…I can’t make sense of many of the movements. Yet, trading is about finding those specific criteria and moments where the next move becomes quite predictable. You don’t have that on truly random charts (or games), and therefore, comparing markets to randomness is likely a fruitless endeavor.

The real market is about thresholds and conviction (and other people’s lack of conviction or changing their convictions), and that is often what drives trends. For example, say I decide to start buying a stock. I don’t even need a reason, I just start buying. Other traders notice this, and also start buying. Anyone who sold to me is now in a state of pain as I continue to push the price up. Eventually they start buying (or covering their short positions) because they fear missing more upside, or their short positions are becoming too costly. As more buyers step I become the seller, unloading my shares on those people. That’s the power of markets…one person or a group of people’s convictions can drive the price (changing other people’s convictions, and thus creating a somewhat predictable outcome), which then brings more people into the fray. Then, as the conviction changes again, the same thing happens the other way. The chart may look random, but we collectively affect the outcome…which makes it not random.

This is why most people lose. They chase the price, and then person or group that started the whole move unloads their shares on these people. The way to make money is research and practice ways of spotting where emotion will be high, and a thus a predictable outcome is likely to follow. Most people don’t know that, and so they buy or sell and hope (with little conviction) they are right….and those are the exact people who will create the high emotion trades that make successful traders money.

Hi Mitchell, thank you so much for the detailed reply, your blog is eye opening, I agree that, chart look same but the causes are different and in trading it is greed and fear, which a trader can know, until the trader knows about it, stock market is similar to random number chart ��

btw we hear all the time that algo trading in majority, how much the greed/fear factor play here? I deploy some of the high speed order placing mechanism through the robotic softwares that i’ve developed but i have no idea on exact mechanism that large auto/hft trading corp use, it is mixture of man and machine?

btw you can take a look at for random chart, just need to refresh or press redraw, funny that you will sometimes see very clear support and resistence lines. Although chart is based on pseudo random numbers but i think its not going be radically different from true random generators made using hardware.

Interesting…those randomly generated charts do look like a real stock chart. But yes, the causes behind them are different.

As for mechanical trading, there is technically no greed and fear on the part of the machine, but it is still impacted by greed and fear since other participants in the market are driven by these emotions. Also, even if the market was all mechanical, the bias and strategies of the traders making the robots would create charts/movements that look like what we have now. The market is still a zero sum game. Regardless of the input (mechanical or man) the end result stays the same…the best traders/programs win, and those that don’t know what they are doing will lose.

right, you are always to the point, I am yet to see any profit thru my frequent scalping…. but i hope things will be different now on.

Excellent article Cory Mitchell, thank you for sharing it. It has been really helpful.

Took a day off from trading and came across this article. It’s certainly one of the best articles on trading I have read. The key takeaway (of many) that I got reading this is that the market is a living organism and is a reflection of the “mood” of the traders in that particular market/instrument. What I am beginning to understand and dread is that in a market like futures/ES for example, even a single contract bought or sold can have a ripple effect on the market. What I have seen trading a simple supp/resis strategy recently seems to support this hypothesis.

My results in SIM are much better than in real trading. This leads me to believe that perhaps there are algos running that tracks open positions and number of contracts being traded. For example, if I am looking for a reversal after a run up (I identify my areas of interest premarket and use order flow) and short 10 contracts at my resis area, can these 10 contracts in real trading actually affect the movement? Are there algos that track that there are now 10 extra (vs SIM) open short positions and continue to push price higher to set off stops? Let’s say it does push price higher to set off stops, and another trader jumps in to short 5 contracts, will that 5 contracts affect price to move higher? Machine learning at it’s finest happening here?

Yes, on small and large scales that happens. Your orders do affect the market, because someone else is on the other side of the transaction and doesn’t want to lose. Whether it is one person or hundreds, there is a collective action of those on the other side of the trade to do everything they can to make you lose (and others on your side of the trade as well). And you, and other trades on your side of the market, are trying to do the same to the people on the other side…whether we like to admit it or not.

Here’s some food for though. I used to trade thinly traded stocks. I would watch the level II and see if I could spot bids and offers which looked like short-term traders. I would then take their shares (whether they were bidding or offering) and then continue to push the price offside on them. The goal was to force them out of their position; when they bid or offered to get out of their position at a loss, I would exit my trade at a profit. It is a zero sum game, if I made money, the other trader(s) lost. This is a small scale version of every single transaction that occurs in every market every day…whether a market is liquid or thinly traded this type of action is going on. It is easier to picture though when talking about only a couple traders battling it out in one stock. It’s not manipulation, it’s not unfair, it’s how the market is set up. Now imagine I and the other trader have millions/billions of dollars to trade with. Other people may see us going at it, buying and selling to each other like crazy trying to force the other guy out at a loss, but it has nothing to do with technical or fundamental analysis. Other traders may join in, not knowing what is going on. Now you have a scenario which reflects every liquid stock/market. That is why I only trade off the price action. My goal is to join a trade as soon as I see one side taking victory over the other, then the other side is forced out and I can ride that price wave.

The premise is the same as what you talk about. Analysis (in day trading) matters but not as much as most people think. It is more about adaptation. I (or others) can push the price for no reason at all except to make you exit and produce a profit for myself. Other traders can do the same to you or me. I now trade liquid instruments because I didn’t like picking on other individual traders, but trading something liquid isn’t any different. I am still trying to take positions where I know the other person is likely to lose. Otherwise I lose. That’s the game.

That doesn’t mean it’s impossible to make money though. There are still patterns that develop. If someone noticed what I was trying to do in those stocks, they could have smoked me, I did get smoked from time to time. Trading is much more dynamic than most people are up against thinking and learning people/machines. They will not politely let you take their money, they will fight back, and try to take yours. Longer-term there are factors which drive large scale social mood changes which affect prices over the long-term. But in day trading it is more like chess match–you see what your opponents are doing and they see what you are doing, and both of you are trying to do what you can to win and outsmart others. For example, some days there are may be patterns where traders are triggering false breakouts and then taking the price back the other way. Instead of getting angry and calling the market unfair, notice the pattern and adapt to it.

ES is probably one of the best markets. I really like it and it is one of the better ones to trade. But make no mistake, the person who fills your order to get into a trade does not want to lose either.

It is not cause for dread though. It is an opportunity. When the price action dictates that buyers or sellers are winning the battle, a fairly consistent price action follows because the losers are forced out. That doesn’t mean you win every trade…I only win about 60 to 65% of the time, but more often than not if you watch price action you can see the shift of who is winning. Sometimes you will be wrong, and that is fine, but align yourself with the trend and those who are in a stronger position and the odds will favor you. If you find yourself on the losing side more often, look at the charts…spot the trend and which traders where/are in a stronger position. Consider why you were fooled into picking the wrong direction (or entering/exiting too early or too late), and then adapt. The Trader Mentoring page has some examples of charts with trades from ES: showing the types of price spots where the odds shift back into the trending/stronger player’s favor.

What if all traders just went long when their trades went against them? Just wait it out. Your cash will be useless until that time but at least it won’t be a loss. And do some traders not use limit stops? OK, I’m not a trader but am trying learn how to manage risk better.

Random Reinforcement: Why Most Traders Fail

Random Reinforcement: Using arbitrary events to qualify (or disqualify) a hypothesis or idea; attributing skill or lack of skill to an outcome that is unsystematic in nature; finding support for positive or negative behaviors from outcomes that are inconsistent in nature—like the financial markets.

One of the most interesting topics in trading, and really throughout many areas of life, is random reinforcement. Random reinforcement, as it relates to harmful trading practices, occurs when a trader attributes a random outcome to skill or lack of skill. The market occasionally rewards bad habits and punishes good habits because the market is so dynamic. It is especially negative if a new trader who wins a few trades, with absolutely no plan whatsoever, attributes this success to “intuition.” Random reinforcement can also hurt veteran traders who experience a string of losses and believe they no longer possess skill. (See also: Trading Psychology and Discipline.)

Random reinforcement can create long-term bad habits that are extremely hard to break. It is equivalent to gambling addicts who keep playing because they win just enough to keep them there, but of course they are losing their money over the long run. A successful card player may also experience a significant draw down, abandon his proven strategy and in doing so give his edge back to the house. (See also: 10 Cleaning Tips to Spruce Up Your Trading.)

How Random Reinforcement Affects Us

The concept of random reinforcement is hard to grasp for some traders, but understanding it can be the difference between actually improving as a trader or simply believing we are improving when we are not. The best way to understand this to go through a few examples.

[You are more likely to avoid the issue of random reinforcement if you consistently and meticulously incorporate the proper technical tools in your analysis. To learn more, check out the Technical Analysis course on the Investopedia Academy, which includes interactive content and real-world examples that can help you along the path to profitable trading.]

Example 1: Relying on Random

John is a new trader. He has a business background, watches the news and follows the stock market, but he has not traded personally. He feels he has a good handle on what it takes to be a good trader, but so far, he has not written any of these methods down. John has opened a trading account and believes his background knowledge will make him a profitable trader. Opening his charts for the first time, John see a default stock in the trading platform, and it is rising quickly. He quickly buys 200 shares without even thinking. The stock continues to rise while he makes lunch. After lunch, he comes back and sells his shares, making himself a $100 profit after fees. John makes another trade and ends up with a similar result. He is starting to feel that he is very good at this and that he must have a “knack” for trading.

In analyzing the situation, experienced traders will notice a few things that could lead to short-lived trading career for this trader. The main problem is that several successful trades are not a valid sampling for if a trader will be profitable over the long run. John, the trader in this case, needs to make sure that he does not fall into the trap of believing that his current methods, which are still very much untested, will bring him long-term success. The danger lies in refusing proper market guidance or methods, whether self created or provided by someone else, because this initial untested method is believed to be superior based on these preliminary trades. The trader can begin to think very strongly that, if it worked once, it can work most, or all, of the time. The markets will not reward erroneous thinking over the long run but may reward random and unplanned trades some of the time. (See also: 9 Tricks of the Successful Trader.)

In the next example, we will look at random reinforcement again, but from a different angle. This example pertains more to experienced traders, or traders who are coming to the market with a written down strategy or method that is back tested or proven to be profitable in live trading. It should be noted that not all methods that were successful in the past will continue to be, as we just found out in the previous example (on a small scale). But methods that have shown success in the past are more likely to provide a chance of profitability in the future than a method that is completely untested or has never been profitable over the long run.

Example 2: Abandoning Strategy

John has now been trading in the markets for some time. He realized that approaching the market without a well thought out, written down and well researched plan was a mistake. He has overcome the problems evident in the first example and now has a solid trading plan for approaching the markets. This method has worked well over the past two years, and he has made money.

John is now facing another problem. Despite past success with this plan, his method has now led him to nine consecutive losing trades, and he is starting to worry that his plan is no longer working. John therefore changes his plan for trading, as he feels his method is no longer valid. In doing so, John ends up trading a new untested method, possibly similar to when he started trading.

The problem in this example becomes evident when John abandons his method, which has been successful, in exchange for an unproven method. This could put John right back to the beginning, even after trading successfully in the markets for a number of years. (See also: Day Trading Strategies for Beginners.)

Why did this happen? John failed to realize that, while randomness can create winning streaks using a flawed trading method, randomness can also create a string of losses with an excellent trading plan. Therefore, it is very important to make sure a trading plan is not actually going to work anymore (was the original success random?) or determine if this could simply be a run of losses based on current market conditions that will soon pass.

All traders experience losses, and there is no definitive number of losing trades in a row that will tell a trader if his or her plan is no longer working. Each strategy is different, but we can learn to deal with randomness. (For more, see: 4 Key Elements to Create a Successful Trading Plan.)

What We Can Learn

Once we realize that randomness can create strings of losses in great trading plans and strings of profits in poor trading plans (and also scenarios that fall in between these examples), how do we adjust to trade profitably over the long term?

While each trading plan is different, each trader must have a written trading plan that outlines how he or she will trade. This plan should be well researched and lay out entries, exits and money management rules. In this way, the trader will know over the long run if the plan is flawed or successful. It is also extremely important to risk a very small percentage of capital on each trade; risk levels of each trade should be covered in the trading plan under the money management section. This gives leeway to the trader, as he or she will be able to withstand a string of losses and be less likely to make a premature change in the trading plan when it is not needed. (See also: Ten Steps to Building a Winning Trading Plan.)

The Bottom Line

The markets are extremely dynamic and in constant flux. This brings in an element of randomness that can create profits for unskilled traders and losses for skilled traders, and it happens all the time. A trader must also determine when a certain string of losses or profits can be attributed their skill and when it is random.

The only way to do this while you are learning is to approach the markets with a trading plan and risk a small percentage of capital on each trade. In this way, the trader can see how a method performs over the long run, in which randomness becomes less of a factor. It is also important to remember that even the best traders and trading methods experience strings of losses, and this is not reason to abandon the strategy. However, isolating why the method is no longer working may help lessen the extent of the losses when similar adverse conditions arise again. (See also: Financial Ratios Tutorial and Investing 101 Tutorial.)

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