Failed Trader – We Know Why 95% Never Make Money Day Trading

Failed Trader: What is the difference between a good trader and a bad trader? Always inverse, says the famous investor Charlie Munger, Warren Buffet’s friend, and business partner.

What is inverse thinking? This is when we turn a problem on its head or look at it backward. If a newspaper headline claims one-third of the population is against passing new legislation, it also states two-thirds approve it. You might develop a strategy that performs well on paper, but instead of trying to approve the strategy, you might want to kill it. If you can’t find any reasons why it shouldn’t work, then perhaps you are onto something.

Similarly, by looking at failed traders, you can find out what not to do. This article lists eleven reasons how to fail as a trader. By making sure you don’t follow what sloppy traders do, you might stand a better chance. 

What is inverse thinking?

Inversion involves thinking and focusing on the opposite of what you want. If you want to be a successful trader, learn what it takes to be unsuccessful (and avoid that). Mr. Munger claims he has been very successful in life by studying how to prevent mistakes and remove errors. After all, if you avoid managing failure, there are not many options left.

Presumably, The Stoics used the same logic and thinking to overcome fear and negative experiences. Done correctly, inversion is a potent tool that can be used in all aspects of daily life. Just think about it: life is a journey where mistakes are made daily. By inversion, you can spot and track potential pitfalls before you do them.  At your job, you can be successful just by showing up on time every day, even though you’re not particularly smart.

We at Quantified Strategies are not particularly smart either. But we have managed to become moderately successful traders and investors for over two decades simply by making sure we:

  • Survive another day.
  • Removing markets and strategies we know are difficult to trade.
  • Avoid investments we don’t fully understand.
  • Make sure we don’t make the same mistakes over again.
  • By not trying to be smart and advanced.
  • By focusing on simple strategies in markets where we can get an edge.

Most energy is spent on avoiding strategies, markets, and behavior that are difficult to master. For example, we are not involved in penny stocks or forex.

Backasting and premortems

Annie Duke offers a different but somewhat similar approach in her book Thinking In Bets called backcasting and premortem. Mr. Munger praised this book.

Backcasting starts with a positive end result, and you imagine how you ended up there. For example, you look at yourself as a successful trader ten years in the future, and you write down reasons and plans on how you ended up successful.

Likewise, you can imagine a negative result in ten years’ time. Annie Duke calls this premortems. Forensic crime dramas are full of postmortems where a medical examiner determines the cause of death (after it has happened). A premortem is an equally bad investigation (as you end up unsuccessful), but before it happens. How did you end up as an unsuccessful trader? Duke argues we are generally biased to overestimate the probability of good things happening. We imagine ourselves as successful traders, even though almost all fail. Being positive is generally a good trait, but being realistic and rational is not bad either.

By imagining obstacles to reach your goal, you are better prepared to avoid and circumvent those obstacles. Dreaming about achieving a goal won’t help. You need to behave in the correct ways that make your goal realistic.

Few ways to win, many ways to lose

There are so many ways to lose, but so few ways to win. Perhaps the best way to achieve victory is to master all the rules of disaster and then concentrate on avoiding them.

– Victor Niederhoffer

This quote from The Education of A Speculator is a brilliant one. It captures the essence of inversion. To not become a failed trader, focus on the pitfalls. However, it didn’t help Niederhoffer from going belly-up with his hedge fund.

So, how do you fail as a trader? Below we give you 11 reasons how to fail as a trader:

Reason 1: Make sure you do it for the money – not passion

Trading is scalable, ie. you can make big money fast. Unfortunately, this is the lure of many aspiring traders, but it’s like getting the wrong end of the stick. If you have no passion, you will ultimately fail. It would help if you had detachment from money. Make sure you love your job.

Reason 2: Make sure you don’t understand the ecology of the markets

Are you the predator or the prey? Make sure you are the prey, and you will fail.

Most traders fail. How many fail? Who knows, but the number is likely above 90%, and traders “making a killing” are probably below 1%. Unfortunately, it makes perfect sense.

Why?

Because the markets are intensively competitive, and in the short-term, it’s more or less like a zero-sum-game. Think about a poker table: all players can’t win. Any poker player wins by raking in chips from the other players. It’s no different short-term in any market, even in stocks. By making sure you are the prey, you are guaranteed to lose money. Make sure you understand the market and its players. Who are the competitors? Who are the predators? What is your edge?

Compare this to long-term investing: the US stock market has risen about 6-7% in real terms since WW2. Why? Because it’s not a zero-sum game. Companies produce value via increased profits, and the Fed keeps on printing more USD. You have two tailw