Tuesday, December 18, 2018

Five Major Reasons Why Traders Keep Losing Money In The Markets

What did you do when the last time?

Your kid spilt the milk...
Your son flunked his exams...
Your subordinate screwed up a presentation...


You made a losing trade...

Photo by NeONBRAND on Unsplash

You went on to lay the blame on someone or something and ended up scolding and humiliating your kid, son, subordinate and in the last case yourself. Are you guilty of doing this? Then go ahead and type "guilty" in the comments window right now, accepting your mistake is the first step to correcting it.

Failure is one word which is frowned upon in our society a lot. It is always linked to the lack of ability of the person who has failed, often criticising the person and not the failure. Laying blame on the individual has caused a fear to set in the minds of people about failing. This is keeping them from exploring and starting new things. And this may come as a shock to you but this attitude towards failure keeps people from learning...

Failure In Trading Means Traders Keep Losing Money

This problem is very severe in the extremely competitive industry like trading. Trading is a game of chances and there are bound to be losses, you can't avoid them. If that is your plan to avoid losses in trading you might as well pick up a different profession.

The main reason why trading business is so uncertain is that trading is an emotional endeavour at the end of the day. No matter how many PhDs and Mathematicians crowd this space, it has always been and always will be a game controlled by the emotions of traders...

If you doubt me go and this fantastic book called, "Reminisces Of A Stock Operator - By Edwin Lefevre" It gives an account of probably one of the great traders the business has seen and it makes it clear that you can't separate emotions from markets...
Fear, Greed & Hope will be here as long as the markets are. - Dean
So why do we keep making mistakes in the markets? or in other words, why do we keep losing in the markets? Let's find out...

Five Major reasons Why Traders keep Losing In The Markets

1. Risk

This includes everything from how much capital you start with to how you treat money subconsciously. There are a lot of things in between, that have a serious impact on your ability to make money in the markets. Let us discuss all the points in detail one by one...

a. Starting With Small (impractical) Capital

This is important, very very important, especially when you consider that most of the traders are trading extremely leveraged instruments like futures and options. Purely from a speculative mindset. I am not saying that speculation is bad, I would be contradicting my self there (because I am a full-time trader myself), but the mindset slowly degrades into thinking trading as easy money.

If your capital is not sufficient then these leveraged instruments will eat it in no time, the professional traders aka smart money are there waiting for you to make mistakes so that they can take your money from you.

Consider the following situation (I am sure many of you may have been through this ordeal)

Starting capital - INR 100,000 (many traders start with this or lower amount)
Instrument traded - Index Futures and Options or Stock Options (this last one is the killer)

Now consider an example of Nifty Futures (as on 18 Dec 2018)

Nifty CMP - 10850
Lot Size - 75
Contract Value - INR 8,00,000 (approx)
Margin required - INR 82,000 (approximated from this website)

So you can trade only 1 lot in this capital...

Now a 1% adverse move in the underlying will result in a loss of approx INR 8000 on the contract value, but for your small account it will be 8% (on your capital of INR 100,000)

Now in today's highly volatile environment, a 1% move is more of a norm than an aberration, what chance does a small account have to stand against this...
Risk is not child's play. - Dean

b. Failure To Understand And Manage Risk

As we saw in the example above the chances for a small account to stand the test of time in this age of leverage and volatile markets are very low. These small losses pile on to destroy your accounts in no time. the key is to trade small and have patience till your account builds to a respectable size.

A popular way to manage risk in the markets is by using a stop loss. But almost all retail traders are using it the wrong way, we will look at an example of that later in the post.

But understand this, your first line of defence is always how much you trade against how much capital you have, stop loss comes later much later. And if you play it well you may not need it at all...

c. Trading Too Big In Relation To Your Capital

Is it correct what I just said, you may not need a stop loss? You bet I did!

Stop loss is used as an inventory transfer mechanism by the smart money. They are always on the lookout for your stop loss and will hunt it down in the majority of cases. So how do you tackle it?

Simple, by making each of your individual trade small and inconsequential to your account size. I know this does not sound encouraging to most small accounts, but there is no way around this one. the only way I can see this problem solved for small accounts is if they trade in stocks (cash basis) and avoid leverage like plague.

Let's look at some numbers...

In the above case let's say we are looking at the account of a wealthy trader one with a capital of INR 50,00,000, now that is encouraging (many of you might be aspiring for such an account size)

The 1% loss which turned out to be INR 8000 is now just 0.16% of your capital. That is chump change...

You can afford to make a mistake which costs you only 0.16% of your capital but gives you an opportunity to learn something from it. That's invaluable. And you can always come back the next day and start afresh, your capital being almost not damaged.

Next, we look at another crucial aspect Market Understanding...

2. Market Understanding

This is a big one. I have seen traders who come to markets start watching some news channels (I mean really!!) read a few books and blogs and start thinking they have made it. Not only that they get the first couple of trades right and start flying on the seventh heaven. But that is where everything goes wrong or at least starts going wrong...

Market understanding is a process, one which can take decades to master. Yet traders want to become successful in one or two years. This is precisely the mindset which is exploited by the snake oil salesmen out there. They lure these gullible people into false promises and false hope of trading profitability, using some doctored trading records and botched up balance sheets.

To improve your market understanding you need to start with the basic underlying philosophies on which the market functions. I am talking about great works of some amazing human beings like Richard Wyckoff's Market Cycles and Schematics, Life Cycle Model or Innovation Adoption Curve by E M Rogers and Auction Market Theory by Peter Steidlmayer.

Unless you immerse yourself into one and all of these philosophies, you will never be able to get the kind of market understanding necessary to become a successful trader.

A special note to some traders who are doing it for decades on end and are doing it even before these models came to light are doing the same thing. These models are developed by observing the works of some of these amazing traders only.

3. Learning

By learning, I mean learning from someone who has done it already. I will give my personal example, I have been trading for well over a decade now, went through almost all technical tools, used every system and tried to learn every method, but still, consistent profitability eluded me. the reason, I never had a deeper market understanding to successfully employ these methods, systems and tools to make money in the markets.

a. Get a Mentor

The solution, apart from pouring over thousands of books and hours and hours of audios and videos you can also make a conversation with someone who has been trading for a while, who is open to sharing his or her learnings with you. Trust me this will cut short your learning curve into the half.

When I look back at my old adamant self, not ready to learn from someone (ego), and then look at the realisations I have made over the years and compare it with the amount of money I could have saved over the years it is really eye-opening.

And I am not even talking about the heartburn and pain of losing. So invest your time and money into someone who is ready to mentor you, teach you a few things. Trust me the amount you will save in the markets or the money you will eventually make will justify the investment you make today.

b. Start Keeping Records

Keeping records of your trades is another way to fast track your learning. Noting down your experiences and learnings for future references will prove invaluable in the long term. I know it is a painful process, but it is essential if you want to become a consistently profitable trader.

It's not necessary to create a trading journal, however, it can be really helpful. Nowadays you can use technology to your benefit, record your commentary (audio) at the end of the day, make a small video at the end of every week so that you can refer to it later on and learn what you were thinking.

Trust me, it helps a lot...

c. Past Is Always Perfect

One of the key things I want you to learn right now is that the past will always look perfect. Each trade setup, each signal, each opportunity you missed looks more and more promising and easy as time goes by. But it is at the right edge of the chart, in real time that you have to make your decisions.

No amount of studying history will help, the history repeats but never in an exact manner. So what is the way out of this conundrum?

Well, LOGIC is the key. Understand why the market does what it does and you are on your way to become a successful trader. I may have made it sound too easy, it is not. But it is possible. I have seen great changes in my trading after I changed my approach.

So drop your preconceived ideas and take the route of logic to look at the markets as they develop in the present. Next, we look at emotions, probably the most misunderstood aspect of trading and an indispensable one...

4. Emotions

There is a school of thought that says you need to control your emotions to trade successfully, I don't subscribe to it at all. Emotions are given to us to help us in difficult situations. Whenever we are in danger or perceive a threat our emotions take over to prevent us from rationalising at the wrong moment, heard about the "fight or flight response"...

But we are no more in a jungle being hunted and chased around by a predator, right. So why do we have emotions still, well our surroundings have evolved a lot faster than our emotional brain, but there are ways we can get around this problem too.

Indecision breeds emotions. So to prevent your emotions from interfering with your trading you need to find a solution for the indecision.

Now indecision creeps in when you don't know the reason behind the moves in the markets. Let's say the markets moved up, but you don't know why it happened, you will not be in a position to make any assessment about its continuation. Is it old and ending or still young and will continue some more?

So once you figure out how to find the reason behind market moves, that is, you can answer why the market does what it does, you are in a position to handle your emotions while trading. Let's look at a few emotions that will obstruct your trading,

a. Greed

This is an old human trait and is at the root of most of our problems. But this emotion is what fits perfectly well with the old trading adage, "let your profits run"... Unless you are driven by greed you won't hold on to your trades when they are in profit to expect some more...

There is a thin line between how much is too much, we have witnessed far too many examples where traders held on to their positions too long and could not bring themselves to accept a reduced profit once the market reversed. Only to give up all the gains and some more. This has happened with me and I am sure many you can relate to it...

Once again knowing why the market does what it does gives you a sound framework to book your profits at a decent level, it may not be the highest or the lowest point but it will be acceptable.

b. FOMO ( Fear Of Missing Out)

This is another strong driver for crazy trading decisions. Somehow the majority of traders feel that the time to make money is right now or never. I mean the markets were there before and they are going to be there for a long time, what's the rush. But some traders just don't get it!

Fear of missing out on the next big move makes traders take some impulsive trading decisions. Instead of waiting patiently they jump in on every signal, only to find that the market doesn't take off at all. The key here is to believe in your trading system if the logic is sound just give it time to play out.

Another fear is the fear of losing the profits you have made. You make a small profit and then start fearing that it will turn into a loss, well it may or may not, but that was never the plan right. I had to struggle with this issue for a long time, which resulted in I missing out on some of my biggest trades.

c. Not Booking Losses / Not Respecting Stoploss


The GIF says it all, if you don't take the losses then the losses will take you. Another sad thing about traders is that they believe losing money is going to put them out of business, the question is how much money? If you are losing a predetermined amount of money, based on your trading plan, that is a legitimate business expense, no need to attach your emotions to it...

Instead, traders avoid losing money, if their trade doesn't work out, instead of getting the hell out with a small loss they stick around for the markets to come back. We all know what happens after that.

Stop loss is your worst case scenario, something which even a sound money management technique cant take care of even. If you are facing indecision when the prices approach your stop loss, it means it was not set far enough to convince you that you are wrong. That is where the trouble lies...

In an attempt to trade as big as possible, retail traders often try to keep their SL small and then end up getting stopped out often. Then they decide not to take an SL and the losses start piling on.

Its ok to lose, but lose small you should. - Dean

5. Framework

This is the big one, one that has answers to all your problems, one which can put you on the path to consistent trading profitability. Let's see how...

A trading framework is a set of logical arguments which help you when you face indecision in the markets. Imagine everytime you come across a tough situation in the markets, someone having your back, someone to bounce ideas of, someone to hold you accountable, someone to tell it to your face when you are taking a step in the wrong direction, well a good framework can do all that and more...

a. Edge

Having a solid framework gives you an edge in the markets. An edge is something which will help you get one step ahead of your competitors. If you are better than your competitors you will take money from them and if you are not you will lose money to them. It is that simple...

So what is your framework? What edge does it provide? How does it let you find out what your competitors are doing? How does it let you thwart their plans or better yet exploit their plans to your benefit? The list is endless, but a trading framework can help you a lot...

Like in my case my biggest problem with the world of technical analysis tools I tried was that they never told me why behind the market moves. As soon as I started understanding Market Profile I became a much better trader because it answered the why of the market moves for me.

So that is my secret what is yours?

b. Predicting The Markets

If for even one second you thought that I will suggest you can predict the markets, then you have got me all wrong. You cant, period!

That, in fact, is the biggest mistake a novice trade makes when trying to learn to trade and make money. You don't make money by predicting the markets, you make it by assessing what it is doing in the present.

Once you understand what the markets are doing in the present, you can then assess the risk in holding a long, short or flat position in the markets. Instead, retail traders try to predict what the markets will do, what is more, worrisome is many snake oil vendors exploit this innate need of human beings to know the future. They sell them false promises, which by the time these poor souls realise, it's already too late.

c. Buying A System

Again this is not a solution, but a trap. Whenever someone tells you where to buy or sell, understand that this ship is going to sink pretty soon, if it's not under already. Trading is a game of chance, as we saw earlier. And nobody can predict where the market is going to go.

So when someone sells you a system with automatic buy and sell signals with 95% accuracy run away...


So what the other side of this story. The other side and a better one is the framework. A framework won't tell you when to buy or sell, but it will empower you to make that decision. The day I realised this I shifted my focus on building a framework instead of a trading system.

A trading system is a small part of an overall trading framework. A framework not only covers entry and exits but includes every other aspect of trading that makes a difference in the long run, viz, risk, psychology, competitors, trading logic, et al.

d. Timing Only After Context

Well, timing is touted as the most important thing in trading, luckily it is not, those people have missed the point. Timing is about minimising risk in a trade, it tells you nothing about whether you should trade or not.

Finding out great opportunities to trade is called the context and it is probably the most important thing in trading. A good framework makes a clear distinction between the two and also gives you enough to be good at both. But strictly in that order, context first, timing after...

If you keep focusing on timing tools and methods, you will end up entering the trade at the wrong stage of market development. For example, you find a perfect setup on a 5 min chart, only to see that the higher time frame traders do not concur with your view. The rout you and your trade and your stop loss are hit. This is a common scenario, I have faced it a lot of times, I am sure some of you can relate.

So another point to stop losing money in the markets is to focus on context first and then on timing.


So that is how the cookie crumbles... I have done my part to give you 5 major reasons traders keep losing money in the markets. if you find yourself doing any one or more of the mistakes, correct them right away. If you don't understand how to do it, hit me up in the comments area below and I will share my learnings with you.

I am sure some of your friends and colleagues may find this piece interesting, I would really appreciate if you could spread the word a bit... Because...

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