Trading is a zero-sum game where about 95% of losing traders will feed the account of the minority of winning traders. How do we explain this high failure rate and why is trading such a difficult activity?
Let’s explore the different answers to these questions.
A challenging market ecosystem
Trading has a near-zero barrier to entry. With a few hundred dollars you can open a trading account and start to enter this very challenging arena by competing against expert or novice retails traders, hedge funds, mutual funds and so on.
This feature gives the illusion of ease and naturally propels a horde of “gold diggers” to seek a living from an activity promising millions in a short time… The reality is quite different.
The market is a world of constant temptation where gratification and punishment arrive instantly with an incredible intensity. When we obey only our emotions, namely fear, hope and greed, without sticking to a proven process that we execute flawlessly, it sometimes feels like we are living multiple lives in one trading day.
There are few activities where one must personally and individually assume 100% of his actions. In a company or in society, individual responsibility is often, if not every time, diluted. An employee can try to minimize his responsibility by invoking the responsibility of a third party. Even a company manager can always shift the responsibility for a malfunction to one or more employees.
In trading every action is 100% the responsibility of the person who undertakes it, i.e. the trader.
Many traders try to blame their failure on the market, which doesn’t even know we exist, or on the market makers, who are supposed to be constantly chasing our stops.
The difficulty to think in terms of probabilities
Casinos invest billions of dollars in a business where it is impossible to know the outcome of each individual bet with certainty. However, they know that they have a statistical advantage in a zero-sum game (the total amount of cumulative gains is equal to the total amount of cumulative losses for any given game), so they will make money with certainty after a sufficiently large series of bets. For example, the advantage a casino holds in blackjack is about 2 to 2.5%. That is, without knowing the outcome of each individual party in advance, on average it will earn 2 to 2.5% on all bets.
Trading as any game works exactly the same way. The problem is that few traders or even investors understand this golden rule. We can’t predict the future, we can only play a statistical advantage (edge) that will make us win consistently after a sufficient number of trades.
But here is a paradox: how can we have an unwavering confidence in our own edge if you we don’t know if and when we will win? The consequence is that many people think they have a trading edge without having one, and even more people never get one just because they give up and change their strategy in the middle of the road because it doesn’t produce the expected results fast enough.
This is why you will often hear or read that you should focus on the process and execute without any deviation a proven back tested edge without considering money if you want to succeed.
This is also why profitable traders will often tell you that trading is boring because everything is planned before each trading session and comes down to pure execution.
The psychological trading biases
In trading, our human weaknesses are magnified while our qualities are crushed. There are exactly 188 known psychological biases that make human beings interpret and perceive things differently from what reality is. It only takes 3 or 4 of them to make trading almost insurmountable for most of us.
Loss aversion is one of the most powerful psychological biases that is extremely difficult to overcome in trading. It is the propensity for human beings to feel a loss more strongly (2 to 2.5 times) than a gain. The consequence is that we are inclined to take small gains and let our losses run when we should have the opposite attitude (cut our losses and let our gains run). The paradox is that by refusing to accept to take our losses we accentuate them.
The second psychological bias that is so harmful to the trader is the confirmation bias which consists of systematically seeking to justify an initial decision, however irrational and detrimental it may be, by looking for specific information. It often leads us to swap our trader’s costume for that of an investor to justify staying on a losing position…
Finally, the bias of overconfidence which consists in thinking that we are smarter than others. It leads us to overtrading, revenge trading, prevents us to take the profits still on the table and encourage us to let our losses run…
A universe of paradoxes…
Trading is an unnatural universe full of paradoxes. What works in a so-called “classical” activity and in our daily life does not work in trading. Let’s take some examples. In life since our childhood, we have always been told to buy as low as possible. For example, if 2 merchants next to each other sell the same type of tomatoes at different prices we will always buy the one at the lowest price.
In trading, the mass of traders recurrently prints trends on all time scales, which are self-sustaining price movements where the higher the price goes (and attracts those who did not profit from it), the higher it tends to go and the lower the price goes the lower it tends to fall.
In short, it is better to buy a rising price than a falling price.
Another paradox is the illusion that a high success rate is the promise of regular and unlimited gains. Unfortunately, the higher the win rate or hit ratio (% of winning trades provided by any given trading system), the more likely the trader is to take small gains and be at the mercy of rare but potentially big losses. On the other hand, one can make a fortune with very low success rates, trying (and failing) many times to enter a massive trend that will rarely but surely make up for the many small losses accumulated between two big winning trades.
Underestimating the work and time required
The last but not the least challenge in trading is not understanding that trading is like any competitive field and that the work required to become regularly profitable is significant. In such a highly challenging zero-sum gain where everybody wants to make money, it is obvious that we must work very hard in order to do what the minority of winners do and not do what the majority of losing traders do. The price to pay is to endure sometimes years of constant and endless losses, discouragement, and dejection before becoming a profitable consistent trader overnight…
You can contact Florian Campuzan (Trading Coach) at florian.campuzan@trading-coach.fr
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