Last Updated on April 2, 2024
The financial markets are highly competitive and in most cases a zero-sum game. It’s not surprising that many traders struggle, but what are the most common reasons? Why do day traders fail? For many of them, it is the jump from hypothetical trading to real-time trading. It’s what they often find the most difficult to adjust to. Sticking to a tried and tested trading plan is easier when you are risking virtual money. Once you’re dealing with real money, fear and greed can take over. There is no difference between hypothetical trading and real-time trading except the added need to succeed. In this article, we will help you learn to avoid some common beginner mistakes. These often become bad habits tackled at a relatively early stage.
What is the Success Rate of Day Trading?
All too often you will see day traders brag about their successful trades. Meanwhile they often end up sweeping the less successful ones under the rug. Therefore, it is difficult to determine the real success rate of day trading. However, some market experts believe the rate could be as low as 10%. Others suggest it may be nearer 30%. Although we do not know for sure, it’s same to assume that the final figure is somewhere within that range.
There is, however, one thing we know for sure. Many day traders find it difficult to stick to their trading plans after going live. They tend not to manage risk with their head but instead they are guided by their heart and “gut feelings”. So how do you fix this?
To be successful, you need to work out your investment strategy. Stick to your stop-loss limits and know when to bank a profit. In effect, run your winners, cut your losers. This will help ensure that you keep your discipline. Just because other day traders follow like sheep doesn’t mean you need to do so as well. Do your own research and if the trade lines-up correctly, then do it. If it doesn’t, walk away. Sounds simple on paper.
The key to day trading success is discipline. Stick to your strategy and if you hit your limits, then deal with it. Uncertainty, confusion, fear, and greed are the worst enemies of day traders.
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Why do Day Traders Fail?
While many people look for a catch-all solution to improve their day trading, there is no simple fix. In reality, it is a mixture of mistakes that you need to address separately. It often down to a lack of focus, a burning desire to prove the market wrong. While many traders know what they want to do, the final push still requires extra confidence. Over the next few sections, we will cover some of the main reasons why day traders might fail. Keep in mind that none of these mistakes are unavoidable. Especially if you stick to your strategy. However, before we move on, let’s see if we can learn a lesson or two from some famous/notorious traders.
One example is George Soros, the man who broke on the Bank of England and made a one billion dollar profit. Another one is the infamous Gordon Gecko, the cutthroat character from Wall Street. They’re famous for making a living off their winning trades, but what about their losses? In reality, it is impossible to be profitable with each and every trade. Markets move, unexpected news emerges and you simply can’t have your finger on the pulse 24/7. It’s impossible to make the right call every time. However, if you are able to cut your losses and run your winners you will see a huge difference. Your overall returns are bound to increase.
What seems too high and risky to the majority generally goes higher, and what seems low and cheap generally goes lower.”
– William O’Neil
In the market, cooler heads prevail. Work on your analysis instead of just hoping for the best and you will get more trades right than you get wrong. That should be the basis of your trading.
Without the bad days, you can’t enjoy the good days, learn from your mistakes, have confidence in yourself, and go for it.
Not Using a Stop-loss Orders
In theory, every new trader will have a stop-loss strategy in mind. It is one of the best means of protecting their profits and cutting their losses. Why is it that so many traders who switch from back trading or forward trading to trading live seem to struggle with stop-loss limits? The reason is simple. It feels unnatural to sell a futures contract or equity when it is going down. That is especially true if you are protecting a profit after moving your stop-loss limit higher in the past. That final push of the button, fighting that thought that you could have made a few extra dollars by selling higher up, it just doesn’t sit well. It feels well, wrong, and many traders crack under the pressure even when they know they should hold on a little longer.
Example
Imagine the following. You have called the S&P 500 E-mini Futures Contracts correctly, and you are sitting on a very healthy profit. In your mind, you’re already trying to spend that money. What can I buy next, how should I spend the profit, should I treat myself to something? That kind of thinking is a mistake. The gains you made on paper is just that until you sell your investment and realize the earnings. Then all of a sudden, the market starts to drift. The S&P 500 E-mini Futures Contract is falling in price, and you are slowly but surely approaching breakeven. In the back of your mind, your thoughts are simple, I got the market right once before, and I will get it right again. Hang in there, it will come turn around..
As the contract slips further down, you move from profit to breakeven to a small loss. You might think if only I had sold higher up! Maybe you feel it is wrong to sell the contract for a loss. You might still hope that the market will pick up. Once the contract price passes your stop-loss limit, you’re in no man’s land. You don’t know which way to turn, and you don’t know what to do. Slowly but surely, the pressure begins to mount. The margin calls come in, and you grow more nervous. This scenario is all too familiar to many traders.
How to Avoid this Problem
The key to stop-loss limits is to do them. Just do them without a second thought. Once they hit your limit, that trade is gone, and you are now looking forward to the next one. Those in the position of moving their stop-loss limit higher and higher as the contract price goes the right way should, at worst, still make a decent profit. At best, they will see the value of their contracts continue to go the right way. Yes, once the market turns and your futures contract follows suit, you will be selling on the way down. You will have missed a little bit of profit, but you will pocket your gains and live to fight another day.
Whether you are using a rising stop-loss limit to protect your profit or avoid taking a loss, if the price of your futures contracts hits your stop-loss limit, hit the button, hit it hard, and don’t think twice.
Not Managing Risk Well
The thing about risk is that without it, how can you expect a return? The risk/reward ratio is what drives traders. It dictates their profits and losses and lets them challenge the market. If there were zero risks in buying an equity or futures contract, then there would be no upsides either. This is because, in theory, all of the news and expectations going forward would already be part of the share price.
Therefore, when you are looking to acquire equities, mutual funds or the ever popular S&P 500 E-mini Futures Contracts you need to appreciate risk and manage it. How much risk are you prepared to take? Is the upside worth the potential risk you take on the downside? Would you flinch at the first tick upwards/downwards and lose your cool? When you take out all of the surround noise regarding investments it comes down to one simple formula, the risk/reward ratio. If you can’t handle risk then you won’t get the rewards.
All investments carry risk. Without risk, there is no reward. Balance the risk/reward ratio and work out whether it’s time to invest. To be successful, you will need to learn to manage risk, embrace it, and use it to your advantage.
Not having a Trading Plan
Investing in futures, equities, or exchange-traded funds without a trading plan is like jumping in your car, driving off the road, and just going forward. Where are you going? How will you know when you get there? What exactly are you hoping for?
There are a wide array of strategies to build your trading plan around, These can include moving averages, stop-loss limits, Fibonacci retracement and price action trading, to name but a few. Each one of these strategies offers a different attitude to risk, a different risk/reward ratio and gives you vision, focus, direction and a destination. The summary of these factors is what will make up most of your trading plan. You may be using a stop-loss, which you can revise upwards as your investment increases in value. In order to be successful as a day trader you should view your stop-loss limit as an insurance policy. When it hits that level, sell, sell, sell. Don’t think about it. Don’t try to second-guess the market, just do it. The strategy will allow you to protect your profits on the way up and also cut your losses on the way down.
A trader without a trading plan is like a car driver without a map, how are you ever going to get to your destination?
Overtrading
Before we examine the dangers of overtrading, there is one lesson you should remember first and foremost, let your winning trades run and cut your losing trades short. A report by finance experts Brad Barber and Terrance Odean casts a fascinating light on the returns posted by heavy day traders and those who were least active. The report showed that, on average, the more active traders underperformed the least active by 7% a year. What was the reason for this underperformance? Overtrading.
The key to trading success is emotional discipline. If intelligence were the key, there would be a lot more people making money trading… I know this will sound like a cliché, but the single most important reason that people lose money in the financial markets is that they don’t cut their losses short.”
– Victor Sperandeo
Trading costs along with the bid and offer spread on many investments can have a serious detrimental impact on your overall returns. Would you believe that according to the same report, investor losses in Taiwan were the equivalent of 2.2% of Taiwan’s gross domestic product in 2016. Most often this is a consequence of overtrading.
To address the issue of overtrading, remember one thing. You will never be judged on the number of trades you do each day, each month and each year. You will evaluate yourself, and others will evaluate you, by your ability to let your winning trades run and then take the profits at the right time. The issue of overtrading is a straightforward one to tackle. Focus on your investments, be cautious but don’t sell too early. You could catch a flurry of relatively small daily scalps, and one unfortunate trade might wipe them all out.
Cut your losses, let your winning trades run, and avoid overtrading. You won’t judge your own results based on the number of trades you made. Your evaluation will be based on the profit you make.
Succumbing to FOMO
The good old Fear of Missing Out (FOMO) is a tried and tested pattern of human emotions. It represents both fear and greed. Time and time again we see a split in investor forecasts for markets like the S&P 500 E-mini Futures. Sometimes bearish traders just can’t see why the index keeps getting stronger and stronger. It doesn’t make sense to them and they steadfastly hold their position. Slowly but surely the continued rise in the market begins to gnaw away at their confidence, they are missing out, the momentum is just too strong then finally they snap. They got it wrong, the market was undervalued and now they’re starting to panic.
When the last of the bearish traders are enticed over to the bull’s side, you can often consider it a sign that the top of the market is close. Those who have been holding positions since the beginning start looking to take their profit, the momentum starts to die, and the index begins to drift. We have seen this time and time again. Investors unwilling to follow the market, skeptical of market momentum, then eventually dragged in because of the FOMO.
What Causes FOMO?
When you decide to take a position, right or wrong, it would have done using your investment/trading strategy. The market appeared overstretched, overbought, and offering little value. At times like that, remember that you don’t have to be in the market all of the time. The longer you hold out before giving in, the higher the price you will pay for your futures contracts. You might have thought it was expensive 100 points lower, but suddenly it starts looking like good value even if it is significantly higher. Some might even call it a herd mentality.
Fear and greed drive markets. They can muddy the minds of investors and make people begin to doubt themselves. However, don’t let yourself get dragged into positions where you don’t feel comfortable. Don’t follow the crowd just for its own sake, because the more “overstretched” an index or stock becomes, the more significant the rebound when it finally succumbs to profit-taking. It almost behaves like an elastic band being pulled further and further away from reality. Don’t get drawn in!
The fear of missing out can sometimes be stronger than logic and slowly draw you in as prices move the wrong way. Don’t chase the last dollar!
Going Live Before Backtesting
Have you ever heard the term, “don’t run before you can walk”, well this is the perfect way to describe those who go live before finishing their backtesting. Act in haste, repent at leisure.
When you do your backtesting you will notice that the same technical patterns emerge time and time again. Learning how to read them, understand the markets, and make an informed decision makes a real and profitable day trader. As one famous day trader once said, being a little late on your trades gives the market time to catch up with your way of thinking.
If you look back at the likes of Gordon Gecko and Bud Fox, these were day traders in the mold of the 1980s. They enjoyed the cut and thrust of the markets, insider trading, and banked huge “profits,” which created the new wave of day traders. If you think of backtesting and even forward testing as a form of “apprenticeship” before taking up the reins as a day trader, you won’t go far wrong. Can you do too much backtesting? Put it this way, can you ever know too much information?
History has a habit of repeating itself. Study the trends, study the signs and take your time before going live.
Not Forward Testing after Back Testing
Once you have done the backtesting, you understand trends, what makes markets tick, and the key signs to look out for. Is that enough? Those who backtest and then forward test (also referred to as paper trading) will actually be able to put their trading ideas into action in real-time. Obviously, when testing these particular strategies, no actual trades are carried out. Paper trades will show when you bought when you sold and what you could have done better, maybe. Learn from your mistakes before you put the monopoly money away.
If we were able to invest in hindsight, we would all be millionaires. If trading results were based on IQ tests, then only the cleverest would make money. It’s not. It takes confidence, an analytical mind, and the ability to make relatively quick decisions in fast-moving markets. Test yourself, test yourself again, and then go back, rethink, and test yourself once more.
The only experience anywhere remotely similar to actual day trading is forward testing. Put yourself in the mindset, and try to feel the pressure of what to do next with one of your large trades. It isn’t easy, and you do need to get into the zone, but this is a priceless experience. You will feel your heart pumping, an adrenaline rush, and a feeling that you can take on anybody. Harness that motivation, determination, and drive but interact that with analytic thinking, trading strategies, and trading discipline, which comes with time.
Hindsight is a beautiful thing, back testing is very useful, but forward testing puts you in the driving seat, tightly holding the steering wheel and in full control. Just mind the bumps!
Going Live with too much Capital but not Enough Results
When you look through the financial press, it seems everyday trader is making a profit. To an outsider, it seems like easy money out there, and you need to get your capital invested as soon as possible. There is a delicate balance between spreading your risk/diversification and going all out on a limb. Yes, you want enough capital at risk to make a decent profit, but you also want to leave yourself enough in reserve to fight another day. It can be very tempting to switch from back/forward testing and hypothetical investment strategies to going all-in on the market.
It is extremely dangerous to trade live with too much capital and too few results to draw experience from. Profitable, breakeven and even losing trades during your paper trading will make you a sharper trader. They will help introduce discipline and simulate the feeling of making a profit and making a loss. Whether hypothetical or trading with reduced capital, you need to feel the pain of a paper loss to understand why it is important to cut your losers and run your winners. Test the water and get slowly acclimated to the market and how it feels to have actual money at risk.
When looking at any investment strategy, you need to have a sense of risk, a sense of balance, and a degree of certainty that you will have at least some capital to fight another day if it went wrong. Going all-in is just a shot in the dark and when it gets to that stage it becomes challenging to recover.
Appreciate the markets, embrace the risk, target the profits but never put all of your eggs in one basket. Very few day traders go “fully invested” just in hopes of one trade that will make or break everything.
Accumulating Data Across Different Market Styles
Stockbrokers need to know their clients, and day traders need to know their markets. Finding the right niche for your skills, your strategy, and your long-term aims will take time, but it is an essential task. For example, day traders need markets that are liquid, volatile with significant daily volumes because the last thing you want is to be stuck in a contract when it goes the wrong way. You need to know whether taking a profit or taking a loss, there is liquidity, and the market can accommodate large trades even in times of extreme volatility.
We have seen innovation over the years, but the move to introduce the S&P 500 E-mini Futures Contracts was a game-changer. The S&P 500 E-mini Futures Contracts are 20% of the value of the original S&P 500 Futures Contracts. Although it was initially aimed at private investors, its introduction of these new contracts inadvertently attracted business away from the original S&P 500 Futures market and created the most popular futures market in the world. This market is open five days a week and 23.5 hours a day – with day traders given the weekend off for good behavior!
Why do day traders fail? Simple, many of them fail to do their research across different markets and fail to appreciate changing trends.
How to Avoid Failure and Become a Successful Day Trader
The above tips will put you on the road to becoming a successful day trader but even so, never stop learning and challenging yourself. Speaking of challenges, have you seen our Trader Career Path® challenge?
The Trader Career Path® is proving to be an extremely popular challenge for traders of varying experiences. Improve as you go by learning in real-time and in just 10 trading days you could secure funding from a proprietary trading firm. Many people have run the Trader Career Path® but only the ones who have what it takes passed. Do you have what it takes?
Do You Have What It Takes to Be a Successful Day Trader?
We know that many day traders fail to realize those regular profits, increase their assets year by year, and unfortunately, many seem to fall by the wayside. There are many ways to avoid failure and become a successful day trader. These include:
- Research, research, and more research.
- Backtesting, forward testing, backtesting, forwardtesting, you get the message.
- Plot your journey. Otherwise, how will you get to your destination? You need an investment strategy, and you need to stick to it.
- Sheep get slaughtered, believe in yourself, and stick to your principles if you need to make some slight adjustments, everything is flexible.
- Managing risk takes time and experience. If the potential return isn’t there, don’t take the risk.
- You won’t be judged on the number of trades you book each year but by the profits you make. As they say, “turnover is vanity, profit is sanity.”
- Never let your heart rule your head; emotion and day trading don’t mix.
- Believe in yourself!
You can do it!
