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The legend of the stock trader who turns pennies into riches is intensely enticing, for obvious reasons. Unfortunately, it often acts like a siren’s song, luring proverbial sailors into jumping ship to chase the dream, only to drown in droves when they hit the water.

That’s the reality of stock trading. It can be incredibly lucrative for the skillful, disciplined, and lucky few, but most people who dive in end up suffering for it. To separate yourself from the crowd, you need to understand why most traders lose money and what the ones who win do differently.

Do Most Traders Really Lose Money?

Before moving forward, let’s examine the premise that stock traders usually lose. While the exact numbers vary, studies on the subject invariably confirm that to be the case. Most stock traders lose money in the short term, and almost all of them lose money in the long term.

For example:

  • A study of eToro users found that about 80% active on the platform lose money, with an average return of -36.3% over 12 months1.
  • A Brazilian study found that 97% of individuals who day trade for more than 300 consecutive days lose money, and only 1.1% earn more than the Brazilian minimum wage2.
  • A Securities and Exchange Commission (SEC) study found that 70% of foreign exchange traders lose money every quarter, and on average 100% of a retail customer’s investment is gone within 12 months3.
  • A study of Robinhood users finds that the platform encourages the trading of stocks with the most outsized positive or negative returns, and the top 0.5% of stocks bought each day loses 4.7% over the following month as a result4.

Ultimately, the specific figures don’t matter much because the lesson is clear. You’re going to have to do something to separate yourself from the majority if you want to be a successful stock trader.

Why Traders Lose Money: The Math is Against You

Stock traders can lose for a lot of different reasons, which is why failure is so much more common than success. Almost all of those reasons fall into one of two groups: technical and psychological.

When I say technical reasons, I’m referring to the simple fact that stock trading is complex, difficult, and high-risk. It takes a lot of time and effort to learn how to do it well, and most people aren’t willing to put in the work.

Once you acquire the necessary knowledge, executing a trading strategy consistently takes a level of discipline that many people lack. Even then, there’s simply no guarantee of success. Let’s review a few of the most significant technical obstacles that cause so many traders to fail.

Predicting the Future Is Impossible

If you’ve spent any time in investing circles or seen the movie The Wolf of Wall Street, I’m sure you’ve heard someone talk about the difficulty of trying to predict the behavior of stocks. As Matthew McConaughey’s depiction of a stockbroker says:

“Number one rule of Wall Street. Nobody – and I don’t care if you’re Warren Buffet or if you’re Jimmy Buffet – nobody knows if a stock is going to go up, down, sideways, or in circles.”

You can do all the technical or fundamental analysis you want, but there will always be factors you can’t account for and a measure of uncertainty. As a result, losses are inevitable, and traders can only hope to wipe them out by winning bigger or more often.

📗 Learn More: Technical and fundamental analysis are the two primary approaches professionals use to pick stocks. If you don’t understand them yet, here’s an introduction to them both: How to Research and Choose Stock (And Whether or Not You Should).

Short-term Volatility and Leverage Are a Risky Cocktail

Stocks are a notoriously volatile asset class, which means their prices can and do swing wildly from day to day. Traders try to take advantage of that by placing bets on whether stocks will go up or down. If they’re right, they profit. If they’re wrong, they lose money.

That volatility means you can get rich overnight, but you can lose everything just as quickly. There are countless stock trading horror stories from people who managed to make it big, only to lose it all because they didn’t know when to stop.

Of course, there are just as many people who never made it big in the first place and instead lost their initial investment right off the bat, never to give trading another go.

To make matters worse, many traders double down on their bets by using leverage, which means they borrow money to fund their trades. A whopping 43% of retail investors traded with debt to increase their potential returns in 20205. With such high risk, one wrong move could wipe out all your gains, principal, and then some.

It’s Hard to Outpace the Increased Taxes and Fees

One of the advantages of adopting a buy-and-hold investment strategy over a long time horizon is that it’s cheap. It saves you money in both taxes and fees, which can mean all the difference between a profitable portfolio and a losing one.

If you wait to sell an asset after owning it for at least a year, you can pay a lower capital gains tax rate on your winnings. Long-term capital gains rates are 0%, 15%, or 20%, and it’s pretty hard to earn your way into that top bracket.

In contrast, traders’ activities are subject to ordinary income taxes, which can be as much as 37%, and the 22% tax bracket starts at just $40,526 in 2022.

Transaction fees are less of a problem than they used to be since so many brokerages offer commission-free trades, but they can still eat up your returns if you’re using the wrong platform or if you’re trading options.

📘 Learn more: Taxes play a huge role in wealth generation, whatever approach you take. If you’re not confident in your understanding of them, check out our overview of the most relevant tax issues: Taxation 101: How Do Taxes Work For Individuals?

Why Traders Lose Money: Psychological Traps

Technical and analytical challenges aside, it’s still incredibly difficult to trade profitably because of some of the facts of human nature. We have inclinations and blind spots that often inhibit our ability to make the decisions necessary to be successful traders.

Most of those problems stem from the fact that we’re social and emotional creatures. Both traits create biases that become disadvantages in a numbers-based game like stock trading. Here are some of the ways they can be dangerous.

You Don’t Know What You Don’t Know, and It Will Hurt You

One of the beautiful things about the stock market today is that just about anyone with an internet connection can sign up for a brokerage account and put their money to work. That makes both investing and retirement infinitely more accessible to the average citizen than they ever have been before.

However, it also means that there’s nothing to stop people from underestimating the difficulty of trading, overestimating their abilities, and getting in over their heads. Unfortunately, humans that are ignorant in a subject tend to be irrationally confident and jump in without realizing how much they don’t know.

👉 The scientific name for this phenomenon is the Dunning-Kruger effect, and it’s responsible for a massive percentage of the people who try to trade stocks and lose. They look at stock trading and think, “How hard can it be?” only to immediately get blindsided by some unforeseen problem.

It’s Hard To Blaze Your Own Trail

If there’s one thing that every successful stock trader has in common, it’s that they find a strategy that works for them and stick to it. That sounds like it should be easy, but it’s much harder than you might think to ignore what the experts and the crowds tell you.

Humans have an unconscious bias toward the things we see other people doing. There’s a reason why most of us dress and speak like the people around us. We like to fit in, and it’s uncomfortable for us to do otherwise, especially when there are high stakes and everyone is vocal in their opinion.

Unfortunately, stock trading has very high stakes, and everyone is vocal with their opinion. Many stock traders lose because they try to get rich by following the advice of a guru that claims to have all the answers or because they can’t help going after what the internet says is going to be the next hot thing.

Many novice traders (and some veterans) are also seduced by the internet buzz surrounding “meme stocks” or heavily hyped “trending” investments. This often leads to investors buying stocks that have already had a runup in price, which decreases the potential for gains and increases the potential for losses. Heavily hyped investments are often overvalued and often have the greatest declines when a downturn comes.

Random Successes Breed Overconfidence

Trading stocks is like playing poker. You have some influence over the outcome, but there’s also a lot of luck involved. Both can make you rich quickly, but you can also lose everything. You have to hedge bets, play the odds, and stick to a strategy to win consistently.

Perhaps the most dangerous parallel between them is that they can both be highly addictive, and it’s almost impossible to quit when you’re ahead. Traders that win tend to misattribute their successes to skill rather than luck and take on more and more risk until everything comes crashing down around them.

A recent study published by the National Academy of Sciences confirmed that investors have a habit of remembering their returns as better than they actually were, which leads to overconfidence, higher trading frequency, and loss of wealth.

☝️ Overconfident traders take on too much debt, overreact to market signals, and fail to diversify. These traders may generate fantastic returns in a bull market when everything is going up. But then they can’t stop themselves, and the market eventually reverses, turning all that glory into misery.

Learn to Trade Like a Professional

If you want to trade stocks, invest the time and effort to do it right. Your financial future is on the line, and if you lose a big bet, you can burn through your savings, push back your retirement date, and even land yourself in debt.

Do your homework before you buy your first stock. Learn everything you can about the markets, trading strategies, different approaches to analysis, and minimizing risk. When you think you’ve learned everything you need to know, study some more because you never know what you don’t know.

Just as importantly, prepare your finances. If you have high-interest debt to pay off or lack an emergency fund, you’re not ready to start trading yet. Build a solid foundation and learn to walk before you start trying to fly.

💡 If you’re not ready to trade, many brokers will let you practice with a portfolio simulator. This can be a great way to get a feel for the process without risk.

Once you’re ready to begin, start small. Even if you’ve done your due diligence, nothing can teach you better than experience. Take a few hundred dollars and give your strategy a try. Don’t start scaling up until you feel confident in it.

Once you have an approach that works for you, stick to it. Don’t let the crowds or the latest guru sway you into chasing the next shiny thing. Do whatever it takes to stay disciplined. Many professional traders choose not to expose themselves to other people’s ideas at all, so they don’t risk being influenced or losing their nerve.

Last but not least, be patient, but know when to cut your losses. There’s a delicate balance between determination and self-destructive stubbornness. If it’s not working out, don’t trade away all your wealth in pursuit of riches.