Many people may portray themselves as big winners of the stock market in a trader community but the truth is that studies have found that 95% or more of day traders end up blowing up their accounts.
The question is, why is it that trading is so hard and what are the top reasons why traders fail? Is it really impossible to make money out of this activity?
In the following article, we will share some of the most common mistakes made by traders that keep them from producing the kind of results they expect.
Table of contents
#1 – Lack of risk management procedures
In trading, how you manage risk is much more important than how much money you make. The reason for this is that a bad trade could wipe out months or years of accumulated gains if risks are not managed adequately.
A risk management policy for a trader is a guideline that limits the extent of the losses that the account may experience if some positions don’t perform as expected.
These procedures may include setting a maximum loss per trade, a maximum position size, and emergency procedures in case the market as a whole suddenly tanks.
#2 – Putting too much money into a single trade
Emotions can get a hold of traders if they ever encounter a trade that they think is “the” trade. Once lured to this alleged opportunity, traders may feel inclined to allocate a significant portion of their portfolio to that single position and that could turn into a disastrous situation if the result is not the one expected.
Most traders who succumb to this urge to pick a big winner tend to experience large losses that wipe out a large portion of their portfolio’s balance and that ends up discouraging them from continuing their journey.
#3 – Not following a system
In trading, a system is designed to generate objective buy and sell signals based on a set of indicators and quantitative variables. Following a system increases the odds of generating consistent results over time while not following one almost guarantees a negative outcome.
The best way to develop a system is to test multiple hypotheses by using back-test tools. You can use this software to see how a system would have performed in previous periods and that would allow the trader to estimate the win rate of said system before it is implemented.
Traders who do not follow a system will be more inclined to “feel” things and that increases the odds of losing money in the market.
#4 – Closing winning positions too early
Two metrics are important for traders, one is the win rate and the other is the reward-to-risk ratio. The latter variable determines how much a trader should make for every dollar he is willing to risk.
The reward-to-risk ratio is crucial to generate positive returns out of this activity. However, it is often difficult to keep winning trades open due to the fear that the gains might be lost at some point if the price trend reverses, or an unexpected development wipes the previous advances.
In this regard, traders who lack the stomach to let winners run will often experience monthly losses as losing trades will drag down the performance of the portfolio and winners will be unable to offset and exceed those losses.
#5 – Unrealistic expectations
Despite what the so-called trading gurus of the internet may say, getting rich by trading is a fantasy unless you have a magic ball. A trader’s journey is no different than that of any other businessperson. Money needs to be invested, there is a learning curve, and profits tend to grow over time as more experience is gained.
Traders who start out thinking that they will be able to leave their regular jobs to travel the world in their private jets six months after starting often face a tough landing when they realize that things are not as easier as they were told.
Trading stocks can be rewarding, fun, and enriching without a doubt. However, most traders tend to fail, and you should learn from these common mistakes if you plan to start a journey in this fascinating world so you can increase the odds of your success.