Stock Market Losers

Losers, and what they do; I don't care what the salesmen, motivational speakers, brokers and your Cousin Bob say to the contrary; losing is the most important aspect of trading. Winning is a distant second.

If you go looking for the typical explanation for why traders manage to lose money with such shocking regularity no matter what they do, you will get one of two answers: either it is an emotional or psychological issue (you couldn't cut your loss, you got out too early due to fear, etc.), or it has to do with poor money management (lack of capitalization so stops couldn't be properly set, etc.).

Well... yeah, but get a step simpler for a minute. If I took a trade in T-Bonds, and the market went up £8,000, is it really likely that I would gradually let that position erode into a £2,000 loss? Maybe you would, but I think I'd be tempted to lock in some part of that fat profit, just in case. Even if it's just a thousand or two, or ten lousy dollars above my breakeven point...

If in that same trade, and I took that position with £2500 in my account with a £2500 margin, and I didn't bother to place a stop because I didn't have enough money in the account to give myself the buffer I would have needed, how much is that going to bite me in the butt if my position is £8K in the black? Not one teensy bit. Inappropriate or missing stops are only a problem if you have a losing position.

...right?

I've reached the conclusion that there is something that underlies the traditional explanation. The cause I've identified is simpler and singular. The reason that people lose money again and again is simply this:

Stock market losers can't pick market direction worth a damn.

No, now hold on, don't just scream "DUH!" and walk away. The implications of this are profound. You just lost seven out of ten trades. How many of these were really because of fear, or greed, or carelessness, or sloppy record-keeping, or that kind of thing? None, dude. You lost money because you said "long" and the market said "short". Now, if you got a big profit and walked away without exiting, and then you got taken out with a loss; then you screwed up on other things. But if you say "long", you get a £50 profit, and then the market tanks, then pure and simple you blew it on the direction.

If you picked a top or a bottom and were wrong, you failed to pick direction again. Relied on a trend line? Stochastics? Moving averages, open interest, volume? Commitment of Traders report, seasonal patterns, cycles, Fibonacci retracement ratios? Median lines, Bollinger bands, head-and-shoulders? Heaven help you, Ken Roberts' 1-2-3? Did you lose? Same thing. You picked direction, and you were wrong, wrong, wrong. Period.

Everything else is subsidiary to this fundamental rule. Small profits that vanish because of a turnaround. Exiting because your loss stop got hit. You can exacerbate the degree of your loss by being stupid or careless or scared or unprepared, but the fact remains that if you went long at 583.20 and the market is at 580, then you messed up your pick.

So, what to do? Realizing that you're being wrong a lot gives you permission to attack any and all aspects of your trading paradigm. You have two choices: You can start looking for a way to be wrong a lot less, or you can accept that you're going to be wrong a lot and figure out how to deal with that. Either way is okay. If you have a system that is wrong 60% of the time, you need to make sure that your 40% winners are significantly bigger than your losers. If you're right most of the time, make sure you don't give it all back when you do lose. And if you can find a way to flip even a couple of trades from losing to winning, all the better. And if you can't find any way to make things any better, be pragmatic! Decide if you'd like to keep losing, or stop trading until you find something new you can use. If you can't find a way to stop losing too much or too often (almost always turns out to be "too much"), then hang it up or give your money to a fund manager unless you enjoy the feeling.

And remember if you never make the same trading mistake twice, you will be reaping the rewards in short time. In fact, most consistent stock market losers are simply making the same few mistakes over and over.

Personally, I'm not that fond of losing. However, I'm using a system that only wins about half the time, because the losses are small and some of the wins are big. It's an important clue, I think.

But HOW do you make the system better? I can't answer that here, because each losing system requires a different answer. If it were as easy as, "Buy this new product," then you and I wouldn't be sitting here talking about losing because no one but the idiots would be losing. Say... nah, never mind. Everybody's trading methodology is different, even when they use the same indicators, so it's really a quest to identify exactly what doesn't work for you. But here are some questions that might help:

Are you trying to pick tops and bottoms? In a downtrend, do you buy in as soon as prices start to rise, hoping to get in on the very start of a big move? Are you forever buying puts in the S&P, hoping for that big crash (that happens once every five or so years)?

Do you have a system that generates good signals, but sometimes you freeze up because you realize the system is probably wrong this time, only to watch a fat trade run to completion without you?

Do you take trades because somebody famous did it last week, or because your broker tells you about a hot opportunity (that he reads from a script typed up earlier that day for all the brokers in the office and gets real vague when you ask him questions about the trade)?

Do you take trades before you've figured out where your maximum pain and loss point will be, so that as the market cruises in the wrong direction you don't have a good, preset plan of how to cut off the bad trade?

Are you taking a lot of trades based solely on probability, with no regard for what the market is doing now? That is, are you long Unleaded Gas because eight of the last ten years it's gone up right about now, and you didn't bother to check any current technical or fundamental information about that market that might shed some light on why it's losing £500 a day per contract?

Are you taking trades based solely on a skew event, such as major historical lows or highs being made today? Meaning, are you shorting because the market is the highest it's been in a year, but you're not looking at anything else the market is doing now, and you haven't made a plan for what happens if the market continues to trend higher for another month?

Are you trying to day trade a market with a method that has you trying to get in and out several times a day with a couple of ticks more than your commission? That is, are you trying to be a floor trader from home?

If you answer "yes" to any of the above, I think we've found at least one big problem. Some of these are fixable; others, you're either going to have to hope for a miracle, resign yourself to your fate, or throw 'em away completely. If none of the above is happening, you're losing in an interesting, creative and a typical way. Maybe you should write a book!