Why do traders usually fail?

A study of Brazilian day traders in that country’s equity futures market, the world’s third-biggest, found that 97% of them who traded for more than 300 days lost money. The authors report, “Only 1.1% earned more than the Brazilian minimum wage and only 0.5% earned more than the initial salary of a bank teller — all with great risk.”

A study of Taiwanese day traders from 1992-2006 (covering the dotcom era) showed that 74% of all day trading volume is attributable to traders with no history of success, and on any given day, 97% of day traders lose money net of trading fees.

A study of over 66,000 households with accounts at a large discount broker between 1992 and 1997 showed that active traders underperformed the value-weighted market index by 10.3%.

eToro itself found that 80% of its users lost money over a 12-month period.

Even when broad markets are roaring upward, as in 1998 and 1999 when dotcom mania pushed the S&P 500 up 30% and Nasdaq up over 100%, a study of 324 day traders found that only 36% made a profit, while 64% made a loss.

Overtrading. Buying and selling shares is costly, even if a trader uses a no-commission broker. The broker might not charge an obvious commission, but behind the scenes it is getting paid to route customer orders to specific market makers, who might not always provide the best pricing. Also, taking gains on a position in the U.S. incurs capital gains tax, which for assets held for less than a year is the same as your ordinary income tax bracket. You can offset gains with losses, up to a point, but if your losses are profound enough to offset your gains, you might be in the wrong business.

Failure to diversify and hedge. This is simply poor risk management, but if a trader is “scalping” – trading in and out of the market to accumulate small gains – it is impossible to have any real diversification. Also, the quick trading turnaround makes it uneconomical and impractical to purchase hedges, such as put options, to protect a position.

Leverage. Investors who use margin loans to buy stocks run an additional risk if the value of their holdings falls. The lender can force the trader to sell the stock to cover all or part of the margin loan. Also, with interest rates rising, the cost of these loans is increasing, cutting into any profits.

Herding. Researchers have found that Robinhood traders are drawn to “attention” stocks – those on social media or top stocks lists. They write that “35% of net buying by Robinhood users is concentrated in 10 stocks compared to 24% of net buying by the general population of retail investors. They conclude that, “Consistent with models of attention-induced trading, intense buying by Robinhood users forecast negative returns. Average 20-day abnormal returns are minus 4.7% for the top stocks purchased each day.” This makes sense – everyone runs for the exits at the first sign of trouble.

Ignorance. Day traders are often counseled to “school themselves by trading.” This may have some merit for trend-following strategies but is no way to get a deep understanding of an industry. It also requires traders to be able to stay liquid – that is, to avoid going bust – for months at a time. Also, successfully learning “on the job” is difficult for even established institutional investors. Buttressing Malkiel’s point and the hedge fund data above, CXO Advisory Group recently completed an eight-year examination of analysts’ market calls, found that on average they were right only 47% - worse than a coin toss.

Emotional decision-making. Loss aversion, the human tendency to feel more pain from a loss than pleasure from a gain, often causes people to hold on to losing stocks longer than they should and sell winners too soon. Combine this with the FOMO-fodder material on social media, and it can be difficult to make rational choices about investments.