Why Do Traders Often Fail

There is a reason why at Keiko we have all transitioned from discretionary trading to trading exclusively with bots, and that is profitability. Long term success in trading is hard, and anyone who has day traded for a living knows the toll it takes. Even when financially successful, the personal toll is often at a great cost.

We use bots to deal with many of the pitfalls of discretionary trading which are largely psychologically based. Wether you are a bot trader or discretionary trader it is worth considering why many traders fail. Here we look at a few of the psychological hurdles to become successful as a trader, using bots or not.

Self-enhancement, also referred to as Self-Enhancing Transmission Bias

We are probably all guilty of it, this is where most everyone prefers to talk about their success more than failure. This causes the inability to accurately assess the ‘real’ situation. Think Instagram where everyone seems to be living the life of luxury and have model good looks. Where in actuality a number of these ‘influencers’ have been caught out using photoshop and a bunch of props in their back garden, pretending to be on an exotic beach.

When it comes to traders, they love to talk about their wins and constantly downplay the losses. The losses are written off as a bad day or was not concentrating at that moment. But unless a trader focusses on the loses, little is learned from the loss and it is bound to be repeated. Yet because the loss is a painful experience the mind will lock it away as a distant memory.

Overconfidence - Dunning Kruger & illusory superiority

A successful trade is because of ones own skill, and the failed trade is bad luck, this is often the sentiment of traders. But this is a cognitive bias whereby people do not acknowledge their own level of ability in a subject. They may know very little about a subject, but think that they know a great deal more than they actually do.
This is covered in more depth in our free Risk-Management course, but here are a few snippets:

In a study of software engineers, 32-42% of ranked their own skill level to be in the top 5%.
Watch any early-round TV talent show and you see the genuine shock on contestants faces when they do not get selected. They are honestly unaware that their illusory superiority has totally misled them.
In a rather ‘hopeful’ survey, 21% of Americans believed that it was ‘very likely’ or ‘fairly likely’ that they would, within the next 10 years become millionaires.
Most drivers consider themselves as better than average.

Outcome Bias

Outcome Bias arises when a current decision is based on the outcome of previous actions or events without regard to how those event unfolded. If a trader has the ‘feeling’ that the market is about to move up, enters a trade and then wins, there is a tendency for the trader to then continue on the ‘my gut feeling says’. Now while this might work for a while, rarely (if ever) is this repeatable and sustainable over the long-haul. This leave the trader who once had a carefully crafted strategy with nothing other than a ‘gut feeling’ which is no longer aligned to the market.

Novice traders tend to be results orientated, whereas professional traders judge their trades by how the trade unfolded and how the decision process was followed.

A novice trader may across the span of a month turn their $100 into $10000 by a series of very high risk and perhaps reckless decisions. They would assume themselves to be a trading rockstar, but any professional trader would see them as an amateur fool who given enough time will blow their account and all the profits.

Confirmation Bias

This is where a trader will seek out information which confirms their own beliefs. It tends to explain why the Bulls remain bullish and the Bears remain bearish, despite what is happening all around.

It can often be seen in trading groups or forums. One trader might post an idea, then another trader confirms that is also what they were thinking and before you know it an echo chamber has formed with everyone agreeing.

Over trading

This probably applies more to discretionary traders than algo/bot traders.

Over trading is often rooted in the wish to make things happen, and an ingrained human condition that to take action often leads to reward. In most industries one succeeds by being busy and earning ones money. Yet in trading inaction and being on the sidelines (not in a position) can sometimes be the most profitable position.

Over trading can be rooted in the fear of missing the next big trade, or even from simple boredom. It feels good to be doing something and being active and this is underwritten by the idea that if ‘you work har you will be rewarded’, something which almost all people have had drilled into them since an early age. Not to say that working hard is a bad thing, but sometimes it is simply a case of slowing down is better for your trading.

Even with our own bots, some days they are extremely busy, but other days they slow down to a snails pace. The bots do not care and only enter a trade when the conditions are correct, but even so, subscribers to our signals begin jumping up and down asking why the bot has not sent a trading signal for the last 8 hours.

Undercapitalisation & expectations

Many novice traders have unrealistic expectations of the gains they ‘expect’ from trading their account. It is not uncommon for a novice trader to have, lets say a $1000 account and expect $100 profit by the end of the week. This maybe because they have seen on multiple online sources stories of real traders making 1 % or 2% per day (see self-enhancement above). The truth is, the level of risk is likely extremely high and unsustainable.

Assume you started with $5000 and made 1% per day, adding your daily profit, to increase your trading equity. By the end of year one you have a profit of $183,917. Just five years later you have more money than the worlds 4 richest people combined. $385,015,581,442.
From just 1% per day… and yes, internet forums and chat rooms are FULL of novice traders claiming how easy it is to make 1% per day, so it must be true!

The reason undercapitalisation causes many traders to fail is they trade too large or too highly leveraged for their account with the expectation of quickly growing their account. They are over exposed and a change in market direction can lead to significant account difficulties. Maybe this means they are stopped out or liquidated, and yet had the trade been smaller the trade could have been managed and closed in profit.

Always trade at a size appropriate to your account size, and regardless of your account size, it is always a good idea to trade with the smallest amount for a reasonable amount of time, allowing you to test your strategy.