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Why do traders lose money?

When Warren Buffett was asked about his first rule of investing, his answer was typically succinct and particularly memorable.  

“Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1.”

 

With these telling words of wisdom behind us, let’s plumb to the depths of why traders don’t follow Warren’s first two rules of investing.

Inexperience. All beginnings are hard, but in this case they can also be exceptionally unprofitable.

Whilst trading isn’t necessarily complicated, it does take some time to become experienced. An inexperienced trader is learning in real time about the markets and how to trade, seeing formations for the first time and dealing with the emotions of trading.

Experienced traders understand that this stage, where they are first developing experience, is a necessary part of the process towards becoming profitable. In the same way that playing in countless, meaningless regular season games, will ultimately prepare you for the world championships. So yes, it is possible to lose at this point, but if you take the necessary steps forward in the right direction, you will eventually head out of this stage towards the championships of profit.

Education

This goes hand in hand with inexperience. Basically, if you don’t understand what you are doing, it’s not that easy to do it successfully.

If you have not been educated or trained to trade, it’s a bit like trying to drive a car without learning first. If you can figure out how to start it, you are likely to crash. Get your hands on a lot of reading material, or find a good trader, just as you would find a good instructor, before you put the key in your father-in-law’s Alfa Romeo.  

Impulsiveness / Poor control

Too many really good traders suffer from this one, more than you would expect. The quickest way to lose money is to turn trading into betting because of poor control or an impulsive need to trade. Think of yourself as a patient predator, you don’t need to attack a herd of wildebeest when other predators might be lurking, especially if you can grab a juicy deer catching a nap by itself. If you cannot control yourself you begin to place ill advised trades and will inevitably lose money.

Not closing out bad positions / poor stop loss management

Even the best traders are susceptible to this one. Sometimes they are more susceptible because they know the market and know that the trade is good. It’s just that the market doesn’t agree with them. And like father time, the market is undefeated.

Not killing a bad position early is the worst thing a trader can do. The further backwards the position goes, the harder it becomes to close. Many great trading activities have been destroyed by an emotional attachment to a position that has steadily moved in the wrong direction. The best thing is to be ruthless with bad positions, and if possible set stop losses when opening a trade. Cutting off a bad position will over the long term, let you keep far more money than that profit position ever would have.

Bad system

If you have a system that doesn’t work, you will lose money. There are theoretically sound systems that for one reason or another remain to be ineffective, or are used incorrectly and lose money. You need to test your system and make sure that it would work in real trading. Sometimes the system works well, but the trader has not integrated it properly, in which case it is unlikely to be ineffective.  

Emotion

Emotion is the primary reason a good system and a good trader goes awry. The pressure and stress of the possibility of the big score is enough to derail trading, as it can be the cause of many losses and regrets. Keep your nerve intact, and you exponentially increase the likelihood of keeping your profits intact.

Adinah Brown

Adinah Brown

Adinah Brown is a professional writer who has worked in a wide range of industry settings, including corporate industry, government and non-government organizations. Within many of these positions, Adinah has provided skilled marketing and advertising services and is currently the Content Manager at Leverate..