Why Most Traders Lose Money and Why the Market Requires It

Learn why most traders lose money, and why that will always be the case. It’s a systematic requirement of the market.
Updated: Sep 26, 2022

While individuals can break from the herd and make above-average returns, the vast majority of people will continue to buy and sell at the wrong times. After reading this invest learning article, you will have learnt from the mistakes of the herd, so you can step into the small group of consistently successful traders. 

This article is broken down in sections:

  • How trends and reversals happen, which is systematic of significant losses by the crowd.
  • The social influence factor that shapes the crowd and lures people into the loser’s circle.
  • The numbers game: the best traders continually take the money of the less experienced.
  • How to break from the crowd and become an independent and consistently profitable trader.

Most traders have heard the statistics “95% of traders lose money” or “Only a few percent of traders make a living at it.”

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While the numbers vary slightly from study to study, the fact is many traders will lose money and it can’t be avoided.  All sorts of reasons are given for the losses, including poor money management, bad timing, or a poor strategy. These factors do play a role in individual trading success…but there is a deeper reason why most people lose.

Most traders will lose regardless of what methods they employ. Even if all traders knew how (keep in mind, knowing and doing are two very different things) to trade successfully based on current conditionsmost traders would still lose over the long run. Let’s explore why that is.

Price Extremes Require Nearly Everyone to Get Onboard

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To understand why most traders lose, we need to look at how prices move. We also need to consider the large number of people who get involved right when the price is about to turn. This is where the mass losses happen.

When a buying frenzy takes hold in a market, it’s hard to see the movement for what it is: something that will pass!  Everything passes. But in the moment, people see other people buying, which makes them think that they if they buy now then other people will buy after them. Anytime you make a speculative purchase, you are doing so because you believe other people will buy after you, pushing the price up which allows you to sell for a profit.

Prices only rise if more people are stepping in to buy than are willing to sell. While we can do all sorts of fancy analysis and make forecasts about price, all we are really doing is making a bet that people will step in to buy or sell. We are analyzing people, because it is people that buy and sell and cause prices to move. And it’s people who cause repeating patterns, that we can trade off of, in the financial markets.

Therefore, an uptrend is created by more and more people continuing to push the price up. A price can’t go up any other way…people need to be willing to pay higher and higher prices. Eventually, there are no more people who are willing to buy at higher prices, or there are more people willing to sell than buy. The people who bought near the top are left holding the losses.

One big problem is that a very large number of people get involved right near the top. For example, a stock has been rising for 2 years and as more people find out about it they start piling in. But there is only a limited number of people who care about that stock and are willing to buy it. Once the masses have piled in, there is no one else to buy and the people who bought earlier in the trend start to sell, which then scares the people who bought late in the trend, and the domino effect begins bringing prices back down.

Let’s look an example: Bitcoin. Bitcoin had been rising steadily between 2016 and 2017, but with not a lot of interest from the general public. Toward the middle of 2017, a lot more people became interested. We can see this by how many people Googled “bitcoin”. We can assume that people searching for information on a product are not experts, but rather want to know more about it. The graph shows that there was an explosion in interest, bringing a whole new batch of buyers into Bitcoin.

People searching “Bitcoin” over time. 100 means peak popularity. Source: Google

Notice how the number of people searching for “bitcoin” coincided with the price of bitcoin peaking. A whole pile of people who had never heard of bitcoin became interested in it, helped fuel the rally, but then popularity hit its critical mass meaning there was no one left to buy. By far, participation was the highest near the top. While savvy investors made money off this buying frenzy, the masses who created the buying frenzy (and the data shows they bought at the top), lost a lot of money.

Avoiding mass losses, and making profits as an individual, will be discussed later on. For now, my point is to show that most people get involved near turning points. Which means most people lose, and are in the fact the catalyst for turning the market the other way. There is a limit to everything, and the mass frenzy causes that limit to be hit.

Along the way up, there will be plenty of people who don’t want to get involved because they believe the price is already too high. But the market keeps ticking higher and so a few of the stragglers join in and buy. Some still hold out and the market keeps ticking higher. Finally, 85% of the population is bullish, and there are still some stragglers…and the market keeps going up. People are proclaiming their achievements and chanting that boom and bust cycles are a thing of the past. Finally, pretty much every person who could conceivably buy is now in…and market plunges the other way.

The chart below shows this in a slightly different way. Since action is more important than talk, when fund managers have almost no cash on hand it means they are “all in” on the market and that means a reversal is likely to occur soon. The problem is that the market does not generally reverse lower until the funds/investors are all in, and it doesn’t move significantly higher until money has been pulled out of the market and most funds/investors are holding lots of cash to reinvest.

Source: Robert Prechter’s April 2010 issue of the Elliott Wave Theorist.

The market is unlikely to reverse to any significant degree until almost everyone is on one side. Which means almost everyone who joined that party late is going to lose. A bunch of people may just decide to wait, but so will the market. And if people are divided, then the market will move in a ranging fashion.

People are the catalyst. Without a large number of people to create an extreme, the market won’t hit an extreme and reverse. In other words, the boom and bust cycles will never end. At least not as long as our markets are a zero-sum game (more on that a little later on).

Attempting to legislate the boom and bust cycles away is nothing more than political pandering. Big uptrends and downtrends are systemic. You don’t have one without the other.

Until almost everyone–who is watching that time frame, and has the ability and interest to trade it–is in the trend, it won’t stop. The trend will keep going, enticing more people in. When it reaches critical mass, which it can’t do without pretty much everyone on board, a reversal occurs.

Unfortunately, the troubles are not over the average person. Not only are most people left holding the bag at the top, they also tend to panic out and sell at market bottoms. Their capitulation selling means there is no one left to sell, so shortly after the price starts rising.

When the outlook is most bleak, because everyone you know is losing money and all you see on TV is how bad the markets are, there is strong incentive to sell and follow the crowd. Once again, the crowd makes a poor decision, which it can’t help doing, and the market turns the other way.

The examples are just meant to show that most people lose by acting in mass at the same time. The masses can’t avoid it, because it is there action that exhausts the trend and reverses it.

Even though a long-term chart of the stock market shows the price of stocks rising, remember that most of the people are flushed out because they are buying near peaks and selling near bottoms. Also, those long-term charts of the stock market, like the S&P 500 index, don’t include the stocks that have gone bankrupt or fallen on hard times. The S&P 500 only includes top companies. If a company begins losing money, it is dropped from the index and therefore has no negative effect on it. But of course that stock still exists and if it performs poorly people will lose money.

Why Most Traders Lose Money – Social Influence

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Successful traders find something that works and stick to it, not letting others pull them away from their strategy. This is where unsuccessful traders go wrong and why the crowd loses money. Despite most people’s best efforts, they can’t pull themselves away from the crowd when it really counts.

When all you hear from your friends and the media is how good this asset is doing, or how bad that asset is doing, it’s hard to take a contrarian view. As humans, we tend to default to availability bias, which is believing what we hear most often.

If you make a bet against everyone else and you are wrong, your friends laugh at you or you feel sheepish. You experience regret for missing out while others profit (even if only temporarily).

There is a social cost to not being part of the crowd. You can’t talk about trades with others, or you need to tread carefully because most people will not hold your view. If you do take an opposite view to the crowd, and you are right, people may hate you because you made money while they lost their shirt. Sound ridiculous?

Consider the public uproar during the Occupy Wall Street protests, or people feeling great resentment for the hedge funds and traders that made billions by seeing the housing price collapse and taking advantage of it! Or the manager who is resented for keeping his job while several of his employees are laid off.

Winning traders are often “crucified” during major market turns when the majority lose. People prefer like-minded company, even if they chat their way all the way to the poor house.

I remember I had a number of radio interviews scheduled in 2008 to discuss winning strategies and profiting from declining prices. The interviews were canceled because the hosts and producers thought talking about making money during a stock market crash was too inflammatory of a topic!

It is very easy to say “I will follow the crowd and get out before them.” Following through on that is quite difficult…which is why crowds move together. Everyone in the crowd thinks that. Also, if you understand bid and ask prices, once people start to sell there are only so many shares are each price level, and so if you want to get out you need to sell to a lower bid price, then a lower one, then a lower one. Everyone can’t get out at a good price…only the quickest and most experienced typically get out before real damage is done.

Everyone sets out to be an individual and trade their own way, and by doing so most end up being with the crowd that loses money. Why? Because each person lets it happen..unwittingly. Their social mood–whether it be optimism, greed, fear, etc.–is likely being fueled by the same social mood prevalent in society. It is no mistake that individuals begin to like the same sorts of fashions that everyone is wearing.

In a quest to change, the majority of society ends up changing together, moving towards similar desires and away from similar dislikes. Therefore, what the market is offering provides the exact thing that will lure the trader into the crowd.

Think about why the spike in bitcoin was so alluring? People thought they were acting responsibly by buying into a new technology that would change the world, just like in the Dotcom bubble. They thought $15,000 to $20,000 per coin was cheap because it would rapidly ascend to $100,000. Such ideas were common in the media at the time. The information that made people think they were making a great trade was being fed to them by the crowd who believed the same thing. Many of these people were not acting independently, even though they thought they were. They all joined forces, herded, and pushed the price up. But no one stepped in after them and the price dropped below $7,000. While the price may go up or down in the future, that doesn’t change the fact that the biggest number of people were lured in close to the top, and will sell near a bottom.

No matter what the market is, once something gets very hot or cold we are more likely to see and hear about it from our friends, through ads, and on the news. In this environment there will be lots of “helping hands” to welcome us into the crowd, teach us to be a part of the crowd, and initiate us into the world of the blind leading the blind.

Why Most Traders Lose Money – A Numbers Game

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Financial commentators will make statements such as “Most professional money managers can’t beat the S&P 500 benchmark.” True. But it is not the professional money manager showing their ignorance, it is these critics who understand nothing about market movements.

Most market movement is created by professional money managers who are managing trillions of dollars in assets, and also by other professionals/businesses who need to transact or hedge risks to carry out their business. Therefore, if the market is up 10% in a year, it is because these professional fund managers have on average bought the market up 10%. Therefore, it is impossible for most professional money managers to make more than 10% that year, because it would be equivalent to asking someone to beat them self at a game of tennis.

Returns will be spread out from negative returns to triple-digit returns, but on average they will have made about 10%, minus a management fee and expenses which means most fund managers will underperform. If the market is up 10%, the average hedge-fund return may be in the ballpark of 8 to 9% after fees, possibly lower.

The majority of investors and traders will not beat the benchmark because they themselves create and are a part of that benchmark!

What is really interesting is that while a great hedge fund may make an average of 20%/year over the last 20 years, the average investor in that fund has a high probability of making far less than that. Why? Because they invest and pull out their funds at the wrong points, just like they do in the market. The hedge fund or mutual fund is a (micro) market, where investors/traders can deposit and withdraw based on how they think the fund will do.

Certain traders do manage to outperform consistently. Many other traders and novice investors come to the markets with a handful of bills and then lose it. There is a steady and continuous stream of these people. They feed the kitties of those traders that are successful. Also, the very fact that so many people pile into (out of) market tops (bottoms) means there are favorable opportunities for those that can keep an objective eye on the market.

In order for the glory stories to happen–such as traders making a 100%.. 500%…2000% returns (whether in one day, one year or several years)–how many traders must lose their shirt (or give up profits) for that to happen? Lots! Look at it a different way. That day trader that made $6,000,000 last year got that money from somewhere. Since small retail traders compose most of the total number of traders (high in number, small in worth compared to professionals) it was likely that $6,000,000 was taken right from those retail traders several thousand dollars at a time.

For a day trader to make $6,000,000 in a year, that means about 120 people lost $50,000 each and/or gave up $50,000 each in potential profit! Or 1200 people lost $5,000. This is a simplified example, but it does provide a perspective not often considered. In order for someone to win, someone else must lose or give up profit.

The big returns that lure people in droves to the markets are ironically what create big returns for others and losses to the droves.

As Individuals Apart From the Crowd

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The crowd is not a crowd until most are involved.

Crowds can’t create strong trends until most are involved.

A trend won’t stop until nearly everyone is on board with the crowd.

When everyone is on board, it reverses.

Since the crowd can’t win, that means only a small percentage of individuals can.

While this article provides a broad context, it applies to the small scale as well. Day traders get caught in the same crowd behavior without knowing it. That rising stock they watch all morning before finally jumping in, only to have it move the other way, is the same phenomenon on a smaller scale. On a 1-minute chart when the uptrend reverses, there is no out there at that moment who wants to buy, and so the price reverses.

Buyers and sellers can get exhausted or elated on all time frames. They experience short and/or long bursts of emotion which result in short and long-term actions/reactions, all leading to patterns which are visible on all time frames. There are are also degrees of bullishness and bearishness across time frames, meaning at times the trends and reversals will be aggressive and at other times more sedate depending on how many traders (and the public) are involved.

Read more: How to use the daily range

Stick to your trading plan

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The bottom line is that traders must stick to a well-defined plan (learn how to make a trading plan) and trade that plan even when it is uncomfortable. The vast majority of the population, and thus the vast majority of traders, buckle under this uncomfortable pressure…the same way we reach for the chocolate bar instead of the carrots.

Since most of the population is more than happy to join the crowd, by having discipline combined with a decent strategy it is possible to be one of the few successful traders who doesn’t take part in the crowd’s losing ways. Day traders, swing traders, and investors can make great returns, but only if they adhere to a few concepts.

Buy an index fund

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If you don’t know what you are doing, buy an index fund and hold onto it. Don’t try to trade. Over many years the market tends to rise, so this is a good approach for someone with little experience or time to learn how to trade properly. It sounds so simple, and yet the vast majority of people get spooked or euphoric and buy or sell it at the wrong time, thus messing up the long-term returns.

Do your own research

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For those who actively want to trade, don’t be lured into the crowd. Think independently, which means doing your own research. Look at charts and see how prices reacted to different events and price patterns. Develop or learn strategies for taking advantage of common price patterns. You don’t need to be right all the time, even if a pattern only works out 50% of the time, but you make more on winners than you lose on losers, that is a winning pattern.

In making your own trades based on your own research and strategies you will sometimes be aligned with the crowd, and sometimes you won’t. But it doesn’t matter. You’re trading your own game, based on statistics you know and trust from doing your research and testing your strategy.

Once you have a method, turn off the TV, forums, and other’s opinions of the market. Their opinion is based on their strategy (if they have one!), not yours. You have done the work on your own strategies, so trust them.

Everyone comes to trading saying they are going to be better than everyone else, or that they just want a little taste of the profits and they will be happy. But to make money consistently means you need be in the top few percent in the world. Being in the top few percent of anything isn’t easy. But it can actually be as simple as buying and holding an index fund for a slow accumulation of profits. That will put you ahead of a lot of hedge fund investors. Or, if you want higher returns which are certainly possible, it involves developing or learning strategies and then putting them into practice more actively (see above).

Discipline is key

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Trading is a process of continual discipline. We are only as good as our discipline. We can be a great trader one day, and piss poor the next if we stop following our plan. Many people think that once they become profitable they can relax. Do you see professional athletes ease off once they make it to the NBA, NHL or the PGA? No, they continue to work hard at what they do…or they fall by the wayside.

The ones who last enjoy it. They enjoy the challenge and the competition. Those who love trading will put in hours without evening thinking about it. Those who only trade to make a quick buck will never be able to compete with the person who loves it and immerses themself in the process of learning and improving. Only trade if you really want to. Without that passion you are at a huge disadvantage to the people who have it.

Good luck on the journey. While I think it’s important to explain things so people know what they are getting into, I am of course a trader myself. I started trading full time in 2005, love it, and don’t want to do anything else. I put in a lot of time to become profitable, and still put in a lot of time to maintain that performance and try to improve. I do believe that anyone with time, dedication, and some capital can be successful at trading. While most people will lose, as individuals we have a choice as to how hard we will work. There is lots of capital out there floating around, which we can learn to grab, but it won’t happen by continually doing what the crowd does.

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