Why Do Most Day Traders Fail?
Most day traders fail because they have no understanding of the path to become profitable. The barrier to entry is incredibly low, and the expectations of massive success are too high.
The analogy that we commonly use is the doctor and the trader. Think about the doctor, and the path that’s required before even getting close to the operating room. A doctor must go through four years of undergraduate study, four years of medical school, five years or more of residency and then become board certified before even thinking about performing their own surgeries.
Now let’s look at the most common path of a day trader. You hear about trading, perhaps watch a few YouTube videos, join an online community, and fund an account by the following week. You take a few trades, some green, some red, and then decide to size up after a winning trade. This is easy! Right? The next trade does not work out, and you’ve gone in with full account size. The account is blown and in the span of one, two, heck six months that trader has “failed.”
The glaring difference is the preparation and expectations of one career vs another. Trading needs to be treated like a career, not just a casual hobby. The barrier to entry for day trading is so low, that almost anyone with a few bucks to their name can get involved in the market. Heck lots of brokers will give you “free stocks” to open an account with them. It’s no wonder that without the proper study and preparation 90% of day traders fail.
Now, you need to spend 10 years learning the market. But you do need to spend more than just a few weeks or months learning the basics and then likely an equal amount of time implementing and refining a trading strategy. You should absolutely not assume that you’ll have a golden ticket to riches in just a few weeks.
A more significant statistic to look at would be considering the rate after weeding out the “quitters” who fold in less than a year. What is the percentage of traders who make it past year one without blowing up the account or becoming ineffective and have gone through an organized education curriculum. It’s probably not an encouraging statistic, and still illustrates that many traders fail, but I would be willing to bet the success rate of traders who meet this criteria is higher than 10%.
Lack of Proper Education and Preparation
Day trading is a skill-based career that requires a deep understanding of the markets, trading strategies, risk management, and technical analysis. Most traders dive into the markets without fully understanding technical analysis, risk management strategies, or even how their trading platform operates. This isn’t necessarily a bad thing, as everyone needs to start somewhere. However the markets are great at punishing those without a plan. A new trader who takes markets seriously will realize they need to pursue education first.
Education can come in multiple forms free or paid. The fastest path to success usually involves finding a mentor who has a trading style that matches your psychological profile. You can learn the concepts that will help you avoid the common pitfalls of new traders, and learn the complete strategy, not just bits and pieces. That’s a major drawback of free information. It’s scattered and incomplete most of the time.
It’s likely that you’ll have to make a considerable amount of mistakes yourself before you truly embody lessons that your mentor has tried to pass along. You’ll more quickly be able to identify and learn from the mistake though as compared to trouble shooting free and incomplete information.
Inadequate Risk Management
Many new traders underestimate the need for a rock solid risk management plan. The flashy and fun part of trading usually revolves around strategy development and learning technical analysis. Everyone wants to draw with crayons, no one wants to calculate their max risk on a trade. However, only one of these things will keep you in the trading game. Taking the time to understand risk principles will serve you in the long run. At most prop firms, if you break a risk management rule, it’s grounds for being fired.
A recipe for disaster is giving new traders excessive leverage. A trader only focused on the upside fails to set stop-loss orders, and ignores position sizing principles. Without a disciplined approach to managing risk, losses will quickly outweigh potential winners, and the account will be blown.
Emotional and Psychological Factors
Day trading is emotionally challenging, and the ability to manage emotions is key to successful trading. As we all well know, greed, fear, and impatience can cloud judgment and lead to irrational decision-making. When you get overly emotional you chase trades, ignore trading plans, and throw risk management to the wind.
Emotional resilience is a callus that must be developed over time. The more experience you have in front of the screens the more likely it is that you will make the right trading decision for the moment at hand. This once again speaks to expectations and experience in the market.
Conclusion
The high failure rate among day traders is totally understandable. The barrier to entry is so low, and the expectations for massive success is so high. Trading being a skill based career, requires dedication to a structured learning plan, and understanding that you’ll need to spend some time in the game to build the resiliency required to adapt to ever changing markets.
Remember the plight of the doctor, thirteen years just to perform a surgery under their own license. Although it may not take you thirteen years to become a profitable day trader, it will likely take more than just a few months. Highly rewarding careers don’t come without expense and day trading is no exception.