Why Most Spread Traders Lose Money
To research this topic, we surveyed three groups of traders: brokers, individual traders and former traders. Here are the main reasons they believe most spread traders lose money.
1. They don’t use stop loss orders.
They don’t enter a stop as soon as they get a fill. Also the act of entering a stop is not enough. You must know where to place it. A good, written trading plan can help you decide. It should tell you specifically how much you are going to risk on a trade. Then you place your stop accordingly.
Properly placed stops can help prevent some of the most serious, costly mistakes a trader can make, such as:
a. Not cutting losses short.
b. Staying with losing positions.
c. Not taking small losses.
d. Losing most of one’s capital in one or two trades.
e. Falling into the ‘I hate to be wrong,’ trap.
f. Listening to anyone who encourages you to abandon your trading plan in order to stay in a losing trade, even one tick beyond your stop.
2. They don’t have a good written trading plan.
A good trading plan can help you avoid these common mistakes:
a. Taking too much risk with too little profit potential. This is why it’s good strategy for you to figure the risk/reward ratio before you decide on a trade.
b. Trading illiquid markets.
c. Adding to a losing position(s).
d. Risking too much money on one trade. Many successful brokers and traders recommend that you risk no more than 2% of your capital on a trade.
e. Using too much capital for margin. 25% is the maximum suggested.
f. Not checking your statements for errors in a timely fashion.
g. Over-trading. A good trading plan only lets you trade as much as your plan’s margin limits allow.
h. Missing opportunities to short the market. A good plan should consider all potential market moves.
3. Their trades are based on local, superficial, insufficient, or no information.
Many traders judge markets only by their local situation rather than looking at the whole picture. Traders will often jump into a market based on a story they just heard about or read in the morning’s newspaper. Current prices almost always reflect this information before it is published. Typical spread traders simply don’t spend enough time and effort learning about the markets. Some even day-trade with little or no information and try to scalp the market. Most brokers, traders and ex-traders say this approach almost never works. And finally, traders who don’t do their homework are often susceptible to placing trades based on rumours and tips which usually come from so-called ‘reliable but unidentified’ sources. Experienced futures professionals say that rumours and tips are worth what you paid for them – i.e. nothing!
4. They don’t manage their money.
You have heard about the importance of managing your money throughout this course. The best way to do so is to incorporate money management as part of your written trading plan. You should budget your capital. Many experts advise that you risk no more than two percent of your equity on a trade, so you will have enough to survive several losing trades.
Another important aspect of money management is to look for trades with favorable risk/reward ratios. Written money management rules should also include guidelines for building and exiting winning positions.
5. They have no discipline.
Many ex-traders say how they lost by going against the trend, trying to pick tops and bottoms. They suggest you aim to take profit bites out of the middle of a move. Charts tell the story. They can keep you from bucking a trend – a major error that can cause major losses. They may also help you identify when a market has turned. You must be able to recognize the difference between trending markets and trading markets. If you don’t know how, ask a good broker.
6. They have no discipline.
You must have discipline to follow a written trading plan. Lack of discipline can cause the trader to:
a. Abandon a trading plan, particularly during or after significant gains or losses.
b. Rush into or out of a trade without enough information.
c. Be impatient and trade impulsively.
d. Trade too many markets with too little information and too little capital.
e. Ignore charts.
f. Fall victim to their emotions.
g. Not use stops.
7. They don’t start with enough money.
Starting with a significant amount of money alone is not the answer. Too many traders started with plenty of money and still lost. They did not have a written trading plan with strict money management rules that emphasize loss control. They did not have discipline.
It is better to start with less money and follow all the rules than to start with more money and trade recklessly. How much is enough? You can figure it out yourself. It depends on your trading plan and how much you are going to risk per trade. It also depends on how much of your equity you are going to use for margin.
If you are going to risk as much as 5% of your capital (the high side) per trade, you would need to maintain at least $10,000 in your account if your risk limit per trade is $500. But many traders and brokers suggest you start conservatively.
Therefore, if you are going to risk 2% of your capital per trade, you would need to start with $25,000 if your plan calls for risking no more than $500 per trade. Experiment with these numbers. Perhaps you’ll want to place your stop where you would attempt to risk no more than $250 per trade. Be sure to select a market where your loss limit is far enough away from the market to give your trade a chance.
8. They don’t let profits run.
A good plan can help the trader let profits run. A good plan can help remove emotion from the decision. A good plan can say, ‘If the market is trending in favor of the trade, profit protection trailing stops will be placed, monitored closely and moved as necessary. These stops will be no more than (a specific amount) away from the market.’
A good plan can say, ‘If the fundamental reasons the trade was initiated are still valid and the technical indicators confirm the trade, the trade shall not be liquidated. If there are profits of at least $5,000 (or whatever amount you chose for your plan), 50% (your choice) of the position shall be liquidated.’
The plan should provide for adding to a winning position if the circumstances warrant. It is important that the price levels and profit goals be in writing. These written guidelines are intended to keep the trader from taking small profits if the fundamentals and technical indicators suggest the likelihood of the move continuing.
However, it is critical that you exit winning trades quickly if the fundamentals, as well as the technical indicators, fail to confirm your position. It may not always be realistic to expect clear-cut information and direction. The trader should be looking for a preponderance of evidence for deciding when to exit part or all of a winning position.
9. They let their emotions affect their trading.
Interviews with top traders indicate that they trade unemotionally. They don’t equate their self-worth with their trading. So they have no problem admitting they’re wrong and exiting a trade. Unlike many traders, they don’t use the markets to feed a need for excitement. They don’t enter a market out of boredom.
The emotional fear of loss keeps many traders from exiting losing positions. For many traders, simply being in the market distorts their judgment and causes them to trade with emotion. Some traders are on an ego trip and won’t take advice from another person. Every trade and how it’s handled must be their idea. Some traders’ emotions keep them from being flexible enough to change their minds or opinions even when the trend moves clearly against them. One of the main benefits of a written trading plan is that it helps remove emotions from the trading decisions.
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