8 reasons why stock market traders lose money

[K.Karthik Raja]

8 reasons why stock market traders lose money

Many people think trading is the simplest way of making money in the
stock market. Far from it; I believe it is the easiest way of losing
money. There is an old Wall Street adage, that "the easiest way of
making a small fortune in the markets is having a large fortune."

I discuss below eight ways of undisciplined trading which lead to
losses. Guard against them, or the market will wipe you out. I am
qualified to speak on this subject because I was myself an
undisciplined trader for a long time and the market hammered me into
line and forced me to change my approach.

1. Trading during the first half-hour of the session

The first half-hour of the trading day is driven by emotion, affected
by overnight movements in the global markets, and hangover of the
previous day's trading. Also, this is the period used by the market to
entice novice traders into taking a position which might be contrary
to the real trend which emerges only later in the day.

Most experienced traders simply watch the markets for the first half
of the day for intraday patterns and any subsequent trading
breakouts.

2. Failing to hear the market's message

Personally, I try to hear the message of the markets and then try to
confirm it with the charts. During the trading day, I like to watch if
the market is able to hold certain levels or not.

I like to go long around the end of the day if supported by patterns,
and if the prices are consistently holding on to higher levels. I like
to go short if the market is giving up higher levels, unable to
sustain them and the patterns support a down move of the market.

This technique is called tape watching and all full-time traders
practice it in some shape or form. If the markets are choppy and
oscillate within a small range, then the market's message is to keep
out.

Hearing the message of the market can be particularly important in
times of significant news. The market generally reacts in a fashion
contrary to most peoples' expectation. Let us consider two recent
Indian events of significance.

One was the Gujarat earthquake that took place on 26 January 2001 and
the other the 13 December 2001 terrorist attack on the Indian
parliament. Both these events appeared catastrophic at first glance.
TV channels suggested that the earthquake would devastate the
country's economy because Gujarat has the largest number of investors
and their confidence would be shattered, making the stock market
plunge.

Tragic as both the events were, the market reacted in a different way
to each by the end of the day. In both cases the markets plunged
around 170 points when it opened, in both cases it tried to recover
and while it managed a full recovery in the case of the Gujarat
earthquake, it could not do so in the Parliament attack case.

The market was proven correct on both counts. The Gujarat earthquake
actually held the possibility of boosting the economy as
reconstruction had to be taken up, and also because most of the big
installations, including the Jamnagar Refinery, escaped damage. In the
case of the attack on parliament, although traders assessed that
terrorist attacks were nothing new in the country but the market did
not recover because it could see some kind of military build-up ahead
from both India and Pakistan. And markets hate war and uncertainty.

In both these cases what helped the cause of the traders were the
charts. If the charts say that the market is acting in a certain way,
go ahead and accept it. The market is right all the time. This is
probably even truer than the more common wisdom about the customer
being the king. If you can accept the market as king, you will end up
as a very rich trader, indeed.

Herein lies one reason why people who think they are very educated and
smart often get trashed by the market because this market doesn't care
who you are and it's certainly not there to help you. So expect no
mercy from it; in fact, think of it as something that is there to take
away your money, unless you take steps to protect yourself.

3. Ignoring which phase the market is in

It is important to know what phase the market is in -- whether it's in
a trending or a trading phase. In a trending phase, you go and buy/
sell breakouts, but in a trading phase you buy weakness and sell
strength.

Traders who do not understand the mood of the market often end up
using the wrong indicators in the wrong market conditions. This is an
area where humility comes in. Trading in the market is like blind man
walking with the help of a stick.

You need to be extremely flexible in changing positions and in trying
to develop a feel for the market. This feel is then backed by the
various technical indicators in confirming the phase of the market.
Undisciplined traders, driven by their ego, often ignore the phase the
market is in.

4. Failing to reduce position size when warranted

Traders should be flexible in reducing their position size whenever
the market is not giving clear signals. For example, if you take an
average position of 3,000 shares in Nifty futures, you should be ready
to reduce it to 1,000 shares.

This can happen either when trading counter trend or when the market
is not displaying a strong trend. Your exposure to the market should
depend on the market's mood at any given point in the market. You
should book partial profits as soon as the trade starts earning two to
three times the average risk taken.

5. Failing to treat every trade as just another trade

Undisciplined traders often think that a particular situation is sure
to give profits and sometimes take risk several times their normal
level. This can lead to a heavy drawdown as such situations often do
not work out.

Every trade is just another trade and only normal profits should be
expected every time. Supernormal profits are a bonus when they --
rarely! -- occur but should not be expected. The risk should not be
increased unless your account equity grows enough to service that
risk.

6. Over-eagerness in booking profits

Profits in any trading account are often skewed to only a few trades.
Traders should not be over-eager to book profits so long the market is
acting right. Most traders tend to book profits too early in order to
enjoy the winning feeling, thereby letting go substantial trends even
when they have got a good entry into the market.

If at all, profit booking should be done in stages, always keeping
some position open to take advantage of the rest of the move. Remember
trading should consist of small profits, small losses, and big
profits. Big losses are what must be avoided. The purpose of trading
should be to get a position substantially into money, and then
maintain trailing stop losses to protect profits.

Most trading is breakeven trading. Accounts sizes and income from
trading are enhanced only when you make eight to ten times your risk.
If you can make this happens once a month or even once in two months,
you would be fine. The important point here is to not get shaken by
the daily noise of the market and to see the market through to its
logical target.

Remember, most money is made not by brilliant entries but by sitting
on profitable positions long enough. It's boring to do nothing once a
position is taken but the maturity of a trader is known not by the
number of trades he makes but the amount of time he sits on profitable
trades and hence the quantum of profits that he generates.

7. Trading for emotional highs

Trading is an expensive place to get emotional excitement or to be
treated as an adventure sport. Traders need to keep a high degree of
emotional balance to trade successfully. If you are stressed because
of some unrelated events, there is no need to add trading stress to
it. Trading should be avoided in periods of high emotional stress.

8. Failing to realise that trading decisions are not about consensus
building

Our training since childhood often hampers the behaviour necessary for
successful trading. We are always taught that whenever we take a
decision, we should consult a number of people, and then do what the
majority thinks is right. The truth of this market is that it never
does what the majority thinks it will do.

Trading is a loner's job. Traders should not talk to a lot of people
during trading hours. They can talk to experienced traders after
market hours but more on methodology than on what the other trader
thinks about the market.

If a trader has to ask someone else about his trade then he should not
be in it. Traders should constantly try to improve their trading
skills and by trading skills I mean not only charting skills but also
position sizing and money management skills. Successful traders
recognise that money cannot be made equally easily all the time in the
market. They back off for a while if the market is too volatile or
choppy.