Friday, October 1, 2010
Guest Article on Forex Trading
Why Do 95% of Traders Fail?
Most people who decide to embark upon the journey of becoming a professional trader in the stature of the legendary George Soros have no idea how difficult the path to consistent profitability is going to be. New traders often think they will be able to open a trading account with as little as $10,000 and be able to live off of trading profits the rest of their lives. But oh, how different reality tends to be. Everyone knows the industry statistic that 95% of traders fail. That is reality. Most traders who open a trading account will lose most or all of the trading account within a few months.
Many people will realize the reality of life as a trader is much more difficult than what they had originally anticipated; thus, they give up on trading and move on to a new professional pursuit. Then, there is a second group of people that blow up that first account, but they develop a love for trading and decide to refund the account, study, and continue toward the quest of consistent profitability. Eventually as the months and years go on, more and more of this remaining group of traders fall by the wayside and give up on the dream of trading consistently. And in the end, only about 5% of traders succeed and make a legitimate living from trading financial markets. The question we need to answer is why?
I believe it can be argued that a large majority of the 95% of traders that fail, fail due to preventable reasons. In other words, there are practical things traders can do to prevent failure, and unfortunately most traders do not implement these practical steps. In this article we will address one specific step traders can take to dramatically increase the probability of trading success over the long-term.
Before we delve into the specific action step, let’s examine more closely why traders fail. Although there are many generalities such as lack of discipline, poor money management, etc, the real reason traders fail is simple—they are losing money! Why are they losing money? It has to be one of two reasons. Either they do not have a strategy that yields positive expectancy (makes money over time), or they do not execute their strategy. Every trader who has failed and given up on trading has failed because of one of these two aspects of trading.
Fundamentally, a technical trading strategy must yield positive expectancy. Positive expectancy is a statistics term from mathematics that means when the strategy is backtested over historical data, it yields positive expectancy, or it makes money. If a strategy cannot make money when tested over historical data, then it has negative expectancy, and cannot expect to produce profits in the future. Thus, a trader who trades a strategy with negative expectancy has no chance of profiting in financial markets over the long-term, even on a forex demo account.
Thus, a trader must test his strategy over historical data and prove that his approach makes money. This can be done in two ways. The first is to have a programmer code out the strategy and then backtest the strategy and gather hard data concerning win/loss percentage, max drawdown, average winner, average loser, etc. All of this data should be analyzed very closely in order to assess how to best trade the strategy in real-time in order to maximize profitability. This exercise will give you a huge amount of confidence in your trading strategy, and when it is not performing at its peak, you will have the ultra-important element of confidence in order to continue trading the strategy and not give up.
The second option you have is to manually backtest the system. This includes scrolling back through years and years of historical data with forex brokers in order to test your strategy in all market conditions. Each time the setup occurs, take notes on whether the strategy was a winner or a loser, and why. This style of backtesting is much more tedious and consumes much more time, but it can bring an even stronger sense of confidence to a trader.
In conclusion, there are many reasons that traders fail, but one of the primary reasons is that they have not become convinced of the merits of the strategy they are trading, and this is absolutely essential to long-term success as a trader. Conducting personal research will help invaluably.