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Not So Secret Reasons Why Traders Lose Money

Breaking the cycle of malinformation

Many well-meaning trading educators will obscure the real reasons why traders lose money and tell you that professional traders are first and foremost risk managers who are in control of their emotions. They make it sound like risk management and knowledge of trading psychology are the solution to all traders’ woes. At the same time they probably share with you that the average life span of a retail account is just slightly longer than that of a fruit fly. In doing so, they just proved their ignorance of human psychology by associating trading with danger and, consequently, fear. We are faced with many cognitive biases that influence our decision-making in trading and everyday life, but you must immediately disassociate yourself from such statements (and possibly also from the sender) for your own sake.

In light of this, it just makes perfect sense however that brokers and FCMs promote loss-minimizing risk management techniques to maximize profits from transient accounts. An army of trading educators facilitates this conditioning process of naive beginner traders. Unfortunately, many of them never manage to shake this initial round of brain washing and survive the subsequent financial losses.

Industry old-timers like to call this evolutionary process “paying your dues to the market”, while others dismissively call retail traders dumb money. Looking at the number of hedge fund closures since 2008 below and the continued popularity of index investing makes you wonder whether small traders exclusively deserve this exclusive title.


Who's the real dumb money now? Hedge fund openings and closures since 2008Hedge fund openings and closures since 2008.
Hedge fund closures – The dumb retail money myth



The value of information in trading

Common platitudes and clichés intended to make new traders and keep veteran traders believe in the viability of trading such as “cut losers short and let winners run” or take emotions out of trading by automating everything. This oversimplifies the complexity of trading decisions and at the same time disparages the most powerful data processing tool you have at your disposal — your intuition. It works on the “garbage in, garbage out” principle, so be careful what you feed it with (also see 03 Emotional Reactivity in Trading and 05 Market Ecosystem Analysis on this). Basic knowledge of risk management and trading psychology alone will certainly make you a good customer, but not necessarily a profitable trader.

You need independent thinking skills to identify trading opportunities because without actionable ideas there’s nothing to manage but a slowly shrinking trading account and the associated frustration.

To illustrate the danger of such retail trader group think, we will look at one of the main reasons why traders lose money, which is the failure to properly appreciate the value of the little information they hold. So instead of comparing traders on the basis of dumb or smart (which is pretty dumb), let’s look at the level of information they hold compared to each other.

Institutional or informed traders

Every big player in the institutional trading arena is paranoid about information leakage, meaning that other traders become aware of their intentions. The main objective of buy-side traders is to minimize the market impact and gaming of their orders by other traders. In order to preserve whatever alpha their portfolio managers believe to generate, they use order execution algorithms in an attempt to randomize and mask their order flow. If you still wonder whether price movements are always random, this should answer your question. However, they are not always successful in avoiding detection due to the limited availability of liquidity in the limit order book (LOB). Hence, this represents the opportunity for opportunistic traders and HFTs to capture some of the market impact.

HFTs or partially informed traders

High frequency trading firms, in return, are paranoid about situations where they provide liquidity at a loss (i.e. being the counter-party to trades with informed traders). Market makers fittingly call this order flow “toxic” and also developed metrics to measure it called Volume-Synchronized Probability of Informed trading (VPIN). Since HFTs are on the other side of 50% or more of all trades on any given day across all major futures and stock exchanges, they can plug this valuable order flow data into their mathematical models to detect the presence of informed traders and recoup their initial losses on the back-end of an institutional metaorder. Understanding HFT behavior after detecting toxic order flow from informed traders can be of great value to any opportunistic trader and act as the proverbial canary in the coal mine.

group thing why traders lose money

Opportunistic or uninformed traders

Given their tendency to conformity, it shouldn’t come as a surprise that most “educated” retail traders do the exact opposite when it comes to concealing their intentions. Although they are already disadvantaged when competing against better informed traders, the promise of a little convenience is enough to extract usable information from them.

Similar to volunteering private information (a.k.a. user-generated content) on social media platforms that will be monetized by others, retail traders are being trained like Pavlov’s dogs to use order types and risk management principles that make their aggregate position highly predictable for anyone who cares and has the means to exploit this information. This is especially prevalent in spot Forex and CFD markets where brokers and banks exploit resting customer orders and stops without the hassle of mathematical deduction.

Funny thing that it’s solid business practice for institutional investors and traders to be paranoid about the leakage of information. Retail traders, however, are conspiracy theorists when they do so.

Reasons Why Traders Lose Money

The price of convenience

One example of “voluntarily” providing valuable information in trading is the convenient OCO (one cancels the other) or bracket order type. The associated pitch here is to take emotions out of trading. What they really want to say is: “We know that traders lose money, so let’s teach them how to do so as little at a time as possible with minimal effort.”

Let’s break down what happens when you place a market buy order with an attached OCO:

  1. Your buy order gets filled for 1 contract of WTI crude oil at $69, for example.
  2. The OCO simultaneously places a limit sell 30 ticks above and a stop-loss order somewhere below. As a good soldier you’ve been trained to use a reward over risk ratio of 2:1 or 3:1, so the stop is anywhere between 10-15 ticks away.


So far so good. What’s the problem with that? Well, think about how someone would go about to possibly exploit this information. Any ideas?

The time stamp of your filled buy order will be almost identical with the time of arrival of your limit order in the public limit order book. After matching your orders and doing a little math, HFTs will have a very good idea where your and everyone else’s OCO stop is.

In the absence of informed institutional traders, predictable stops are simply the lowest hanging fruit for HFTs and market makers. The convenience of an OCO order – priceless.

Does that mean that using stop-loss orders is a bad idea? Absolutely not, just don’t signal your intention to the market and place your exit orders separately after your entry order has been filled. Of course, you can also exploit this herd behavior by monitoring levels where the majority of retail traders incl. their automated systems enter the market and expect corresponding price moves from obvious breakouts/downs into “OCO stop-fishing” levels. Remember that following any publicly promoted method of risk management or automation without considering the implications will make your orders even more predictable than they already are. Fight the urge and let other traders lose money the old-fashioned way.

You’re not going to be a 1 lot trader forever. So start thinking like a pro, become “paranoid” about your information leakage, detect that of others, and adjust your trading strategies accordingly.


Delusion of competence

Being aware of external factors influencing traders is just as important as the internal factors, which are often driven by mental shortcuts in decision-making – a.k.a. cognitive biases.

For example, the initial rush of knowing nothing about a particular subject to reaching some level of expertise is common across many different situations in life. Young drivers believing that their driving skills are much better than they really are or swimmers overestimating their skill in open water are examples which can result in potentially deadly outcomes.

The same is true for traders who, after learning the basics of risk management and a few trading setups or tools, succumb to similar delusions of competence. Fortunately for traders, the feedback from reality is limited to financial loss and a broken ego in the best case.

The magnitude of this delusion, however, is often magnified by the belief that the more they paid for the associated education the more competent they must have become as a result. This is particularly dangerous if the master’s magnitude of competence delusion is confidently and directly transferred to the student.

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” Mark Twain

Answer this question for yourself to gain a better understanding of your position in your learning journey: Where would you put yourself in the chart below and where along the line would you expect optimal risk-adjusted performance?

reasons why traders lose money Dunning-Kruger effect overconfidence


This divergence between perceived and actual competence – which is also known as the Dunning-Kruger effect – manifests itself as over-confidence between the first two stages of incompetence that often results in excessive risk-taking.

To answer the earlier question about optimal performance, there are three points in a trader’s development where a trader is perfectly calibrated or in equilibrium, meaning that the self-perception of competence matches actual reality:

  1. at the start when both confidence and competence are zero,
  2. at the humbling point where the trader has already advanced in the learning process but reaches the point of conscious incompetence where s/he realizes that there’s still room for improvement or drastic change is necessary, and
  3. after going through a state of conscious competence finally arriving at the third state of equilibrium of unconscious competence.


Being aware of this cognitive bias is just the first step to not fall for it. As a trader, you need to continuously assess your potential level of overconfidence which may result in taking on too much risk due to ignoring certain risk factors. In the end, this is one of the main reasons why traders lose a lot of money in the early stages of their trader development and consequently drop out of the game.


At the end of the day, most of the reasons why day traders lose money simply come down to either being naive (new traders) or gullible (repeat offenders). Believing mantras such as “it takes 10,000 hours of screen time” already sets you up for failure. Instead of naive practice, you should aim for 20 hours of deliberate learning first!

The purpose of true trading education should be to cultivate independent thinking, so that traders are able to identify low-risk trading opportunities without being dependent on a trading guru or magic software tools. The key in day trading is to understand the micro-structure of the market and to know thyself from within and without by answering the questions of “who am I within the context of the overall market?” and “who am I within the context of my own decision-making.”

Ultimately, you may take the view that market makers, brokerage firms, and trading educators are just bad players in a bad game. Wolves, however, only thrive and multiply when plenty of sheep are around.

Alternatively, you can accept the rules of the game and find your own way to take advantage of it. That’s what you get paid for. After all, if you want to make money as a trader – act (and think) like a winner.

A closed mindset will only ensure that you will donate your money to the insiders forever. It’s your choice to keep playing from the outside or educate yourself within the framework of a learning community that promotes independent thinking skills based on factual research. Feeding your intuition by learning how your competition actually ticks is the first step on your journey to unconscious competence and profitable trading.




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