The Real Reasons Most Traders Lose Money

I’ve been involved in brokerage for over 20 years now and have dealt for pretty much every client out there. From the absolute spread bet beginner to $100m hedge funds. And there is one reason why they lose money, and it’s not as complicated as you think.

It’s because in a nutshell, it is because they are amateurs and do not know what they are doing.

The second reason is that clients do not, in general, follow some fairly basic rules of investing i.e don’t overleverage, don’t overtrade, cut your losses and run your profits.

We keep a record of the loss percentages of spread betting and CFD brokers. However, these only relate to retail traders, where the tax advantages of spread betting only apply to individual investors.  These stats do not include traders classified as “professional investors” or hedge funds and institutions.

• Related guide: Spread betting strategies that can help you make money

Overleverage

This is an easy mistake to make as when you think you have a good trade idea, you want to try to make as much money as possible.

You set your trade to take up as much margin as possible.  The problem with this is that it doesn’t leave much room for error.  In trading, you need breathing space for when a trade does not go your way straight away.  If the trade moves against you and you can’t afford to run a small loss to start with you will be on margin call and the broker will close your position because you can’t afford it.

The key stat here is that if you lose 50% initially, you have to gain 100% to get back to your starting balance.

FX margin rates for retail investors are capped at 3.33% so with £5,000 on account, you could trade a £150k position.

If your position moved just 1% against you, your account balance would be 50% less.

Overtrading on spread bets

There is not always a trade in the market and trading just for trading’s sake will lead to quick losses early on.  Traders who are new to the market must be patient and wait for the fundamental and technical indicators to be right before execution.

Research by Odean & Barber (2000), which found that the most active traders underperformed the market by 6.5% per year after accounting for trading costs.

Not cutting losses and or running profits

This is a key element of trading.  Most professional traders only get it right about half the time.  But they win because the can spot a good trade and let it run.  More importantly, they can admit when they make a mistake and cut the position.

This is vital strategy and most new spread betting customers get too emotional.  They hope on hope that a bad trade will turn around, but get too excited or scared when they turn a profit and close it out too early.

This is known as the disposition effect and combined with loss aversion (as covered by Terrance Odean) is why traders tend to hang on to positions too long.

The study analyzed 10,000 brokerage accounts and found that investors realized winners (stocks that had increased in value) at a rate of 14.8%, while they only realized losers (stocks that had decreased in value) at a rate of 9.8%

Why winning trades don’t necessarily make profits

Joshua Raymond the UK MD of XTB (who was at the time the City Index resident market strategist) wrote a nice article on Linkedin, which is basically about how unfair it is that everyone assumes that 90% of spread betting traders lose money.

There were lots of data, charts, and information about how actually 60% of trades in a month were profitable.

But no actual information about whether the net profit or loss was positive or negative.  One would have to assume that as this is basically an article promoting spread betting that if the clients were net up at the end of the month they would have said so.

Placing winning trades is not difficult.  It’s actually very easy to get bets right.  After all, the market will only do one of two things.  That is, it will either go up or down and you are either right or wrong. And with even the most basic use of market timing, a trader can get an edge. However, the difference between good and bad traders and those who make money is the trading strategy employed once a position is open.

It is well known that traders and investors do not get it right all the time.  That is why diversification and breathing room are the foundations of trading.  Where investors and traders always go wrong is that they cut profits too soon and let losses run on for too long.  What traders should do is cut losses and run profits.

However, as with all gambling, spread betting (unless it is being used by professional traders or hedgers) is primarily the playground for “fun money”.  Fun money being a small percentage of an overall portfolio allocated to high risk, high reward trading strategies.  Therefore it’s usually emotion that gets the better of traders.

The thing about losses is that they can get seriously out of control very quickly.  Which can result in one losing trading wiping out the profits of ten profitable trades.  That is a more realistic overview of why people say that 90% of spread betting customers lose money.

Of course, if you want to improve your spread betting strategies you can study up by reading spread betting books.  These books don’t promise to make you rich, what they do is help a consistent approach to financial spread betting.