10 REASONS TRADERS LOSE MONEY
With all the fancy charts, fundamental analysis, and experience with price action, you would think that the majority of traders would be profitable.
The sad fact is that most are not successful. The majority of all traders
contribute to the profits of the minority that are profitable.
Even seemingly successful firms like Amaranth and Long Term Capital Management can, and do, blow up.
Individual traders like Victor Niederhoffer, who looked like a market wizard for
the majority of his career, destroyed more than one account. In fact, 83% of
all active managers have not beaten the SP500 in the past 8 years.
Why is this? If it was just a matter of being smart, then the trader with the
highest IQ would make the most money.
If it was only a matter of charting skills, then the trader with the most complicated charts would be the wealthiest.
Here are 10 Fatal Errors made by misguided traders:
1. A trader must have a trading plan
…with well-defined entries, exits, and position size before they make any trades. Trading with no plan creates random results, and the profits that are won as a result of chance will eventually return to their rightful owners.
2. Traders must have an edge to be profitable.
The traders that have discipline, have done their homework about historical price action, and stay in control of their emotions will make money.
3. The biggest mistake that the majority of traders make at all levels, is that they trade too big.
Big position sizes cause emotions to run high, infringing on reason. Big losses are also more financially and emotionally devastating. The position size of a trade should never put a trader’s lifestyle or trading career at risk.
4. When the markets open, the trader must have the discipline to follow the plan they created when the market was closed.
No system will work if the trader does not have the discipline to follow it.
5. When a trader’s desire to be right is greater than the desire to make money,
..they will let a losing trade run to avoid admitting that they are wrong.
6. Fear of giving back a small profit will cause a trader to miss a bigger winning trade.
7. Most profitability is based on the big winning trades.
A winning trade should not be exited until there is a good reason to do so.
8. If a trader does not take their original stop loss, they will allow small losses to become big losses.
Big losses generally are what cause a trader to be unprofitable. Many good trading systems become profitable simply by removing the big losses from the trading results.
9. Traders that do not account for events outside the known bell curve can be ruined.
Events that have never happened before can happen. Hedges, stop losses, and position sizing are the insurance policies against the sudden risk of ruin.
10. Traders with too much ego will eventually make a decision that
insures a fatal trading result.
Personal predictions have no value, because the future does not exist in the present moment, no matter how strong a trader’s convictions.
Long-term, successful traders have many common characteristics:
-They religiously follow a plan
-They have an edge over the majority of investors
-Risk management and capital preservation is their number one priority
-They go with the flow of the price action rather than predict.
They admit they are wrong quickly, and never quit learning.
The humble and the flexible traders are the most successful risk managers, and they will end up with all of the chips in the end.
-Courtesy SeeItMarket 11/18/14
THE HARDEST PART: WHEN TO SELL?
Most investors are good at picking entry points to buy a stock or ETF, but not so good at knowing when to sell it. How much should a stock rise before it's time to sell 1/2 or a 1/3?
Well, here's one strategy that we thought might be helpful to figure when to sell, courtesy of Jeffrey Hirsch of Wiley Global Finance:
"In my opinion, one of the simplest, oldest methods, and most effective ways to help lock in profits and let your winners ride, especially with lower-priced, smaller-cap stocks, is to sell half on a double. This way you take your initial investment off the table and you let your winnings ride.
Or you can use a slightly more conservative approach. In order to keep it simple and since it is different for everyone commissions, fees and taxes are not considered in the following example :
When a stock goes up by 40%, sell 20% of the position. When it goes up another 40%,
sell another 20%.
This basically leaves you with 125% of the initial position and about 60% of your initial investment off the table.
You can also use this "up 40%, sell 20%" method on the remainder of the position you sold half of on a double.
I think it is also prudent to use one or more outside services to rate your stocks.
When those services show red flags you may want to consider tightening up stop losses for those holdings and becoming even more diligent monitoring them.
To illustrate how to manage a stock position let’s take a look at how my basic
"up 40%, sell 20%" method and "20% stop loss" would have worked on one of the world’s most well-known and influential stocks.
On the chart of the tech stock shown below, I have notated four actions
that could have been taken from 2010 to 2012.
Let's say you decide to buy this stock when a major new product is released in June 2010. You buy 100 shares at the weekly high of $279 (cost $27,900) and employ a trailing stop loss of 20%. It holds above 20% stop, and is up 40% by June 2011. You sell 20 shares at $390.60 and take $7,812 off the table and hold 80 shares worth $31,248.
The stock continues to rise and is up another 40% by March 2012. You sell 16 shares (20% of the remaining 80) at $546.84 and take $8,749.44 more off the table and keep 64 shares valued at $34,997.76.
The stock rockets to over $700 share. When it finally loses 20%, breaking through its 50-day moving average in the process you sell your remaining 64 shares at $560 (20% off the closing high of $700) for $35,840.
This gives you a total profit of $24,501.44 or an 87.8% gain. If you were brilliant and sold at the high you would have had 150%. By taking profits on the way up you had nearly the same gain with reduced risk."
"Finding proper entry points, trading around core positions, and having a sell discipline can be crucial to increasing the returns of the portfolio.
Remaining disciplined, unemotional, and mitigating risk are some of the keys to investment success. Maintaining an unbiased and unemotional stock selection process and consistent portfolio management practices can help with achieving success.
Most importantly, the ability to avoid bad behavior can be the difference
between success and failure in the long run.
Any one of the 7 deadly investing sins listed below can be the ruin of an investment portfolio:
Bad Behavior - The 7 Deadly Sins to Avoid
1. Averaging down into losing positions
2. Over-concentration in too few positions
3. Investing in stocks with low liquidity
4. Falling in love with a stock, position, or a management team
5. Excessive use of margin
6. Over-concentration in one sector
When a portfolio holding no longer ranks among your top ideas it's usually for one of two reasons:
1. The company's results or the price and volume action in the stock show that a company's growth, valuation, and/or momentum has become less favorable, or
2. The stock price goes up so much that the relative attractiveness of the stock diminishes.
Either occurrence may force you to trim losses, take profits and/or find better opportunities.
When factors become less favorable, a natural selection process may lead you to sell a position long before a stop loss is reached and redeploy capital in another more attractive opportunity.
However, a rapid increase in a stock price does not necessarily suggest a stock should be sold.
Sometimes a major move gets underway and you might want to exploit those opportunities.
Just a few of these per year can often have a significant impact on the performance of your
Selling too soon can be almost as detrimental to long-term returns as money-losing trades.
This is why it can be important to harvest gains and then set trailing stop losses."
-Jeffrey A. Hirsch, Wiley Global Finance
WARREN BUFFETT: DO NOT PAY HIGH FEES TO MANAGERS !
As you know, Warren Buffett is a big non-believer in the high fees that
Hedge funds charge, he maintains that just holding the SP500 index fund (SPY)
Will always outperform any managed fund (the famous $1 million bet).
But get this:
“If you invested $1,000 with Warren Buffett in 1965, you would currently hold
a nest egg of $4.3 million. Nice!
However, if Berkshire Hathaway had been a managed hedge fund, charging
2% and 20%, that $4.3 million would result in the investor with $300,000,
But the fund manager would end up with a stunning $4 million!”
This crazy math shows you just how important (and detrimental) financial
fees are to your money, and why you should avoid them at all costs.
The Seven Percent Rule
The “Seven Percent Rule” is a trading method used to cut losses early.
Most successful investors say minimizing losses is even more important
than picking a winning stock in terms of wealth creation.
Investor’s Business Daily cites this technique as crucial to good money
It’s pretty simple: If a particular holding drops 7%, it’s time to sell.
For us, a loss of -3% to -4% would probably get us stopped out prior.
But let’s see how this works:
Let’s say you have a $10,000 investment in a hot tech stock.
But overnight, negative news sends it down 7%, here’s what happens:
$10,000 x -7% loss = $9300 left
In order to get back to even, you would only need a +7.5% gain:
$9300 x 7.5% = $700 + $9300 = $10,000 (back to original)
But if you let that loss increase to -15%, the dynamics change:
$10,000 x -15% = $8500
$8500 x 18% = 1530 + 8500 = 10,000
(You would now need an 18% rise to get back to $10,000)
Now let’s say you lose -25%:
$10,000 x 25% = $7500
$7,500 x 33% = 2,475 + 7,500 = 10,000
(Takes 33% to get back to 10,000)
And a -35% loss pretty much guarantees you’ll never get whole
as you would need a +54% move to get even
$10,000 x -35% = $6500
$6,500 x 54% = 3,500 + 6500 = $10,000
…At -50% loss, you would have to make 100% to break even:
$10,000 x -50% = $5,000
$5,000 x 100% = 5,000 + 5,000 = $10,000
And just how many stocks go up 100%?
For some investors, this mathematical reality is a given.
But for many others, the idea that if you lose 35%, all you have
to do is make 35% to break even is more commonplace than
you would think.
So don’t forget the “Seven Percent Rule.”