3 years ago, January 2016 I was on the phone to client from Canada who had been trading with $1k for 5 months and was ready to increase his stakes. He had been recently divorced and had $40k to invest into his trading account with the brokerage I was working for.
4 months after investing this new capital his balance was $347k. He grew his account in 16 weeks to over $300k from where he initially started. In doing so, he even encouraged his son to open a account with us. By the end of that month, after beginning with a profit of over $300k, he ended with a balance of -$2,300. Eventually he began using his son's account to try to recover his losses. So what happened? After being one of the few retail traders to hit the proverbial jackpot how did he lose it all?
Over Optimism
As humans we have a innate wiring to be optimistic in our pursuits. In financial pursuits and in particular as it pertains to the world of trading our optimism leads us to set unrealistic ambitions or in many cases set none at all, with the notion that “the sky is the limit”.
In most areas of life I agreed we should reach for the stars, however trading requires you to have a greater fear of loss, than hope for success in order to be successful. The client above initially started wanting a return of 35 - 40%, however after surpassing that instantly after his first few trades, he failed to reset the clock, and instead became blinded by his winnings and kept increasing his risk exposure for even further gains, without setting limits. It worked, his gains increased, but so did his ego and his fearlessness in believing he cracked the code to the market. Leading to even further risk taking.
Lack of emotional control
“It’s not you, do not believe your own hype, the markets will catch up to you eventually”. We spoke while he was up as we loved the fact he was trading high volumes and winning, as the more he traded, the better the company did. We had no conflict of interests from him being successful.
Given that we had a good relationship, I asked him "why don’t you quit now?" He didn’t understand the question, he couldn’t see why on earth he would stop now, “I’m just getting started”. At that stage he completely forgot his initial goals and now saw it as a game.
Traders a few years ago were criticised by media for being emotionless, it’s not that a good trader is void of heart, rather the source of realism. No optimism, nor pessimism just pure realism in their ability to make tough decisions. Most people in his shoes without this knowledge would likely have done the same, let there emotions dictate their actions, and essentially this is why 80%+ of average retail traders lose: because they are human.
Bad risk management
Humanity isn’t the only tool for failure, a lack of risk management and diversification are also contributors. The market he traded was mainly gold, which is seen as one off the most volatile. Meaning high swings in price are frequently visible. He was risking upwards of $200 a pip, which is the smallest incremental change in value. So if Gold is valued at $1,310.08, a move to .09 would see you up $200 or down if it hits .07, at the time the markets were moving close to 600 pips a day.
In order to combat this, good traders use low percentages of their overall account size in any given trade. Setting limits to ensure even if the markets go against them, their losses can be limited to the extent of their exposure, proving there is liquidity and no gaps.
Although he initially managed to get ahead without following any of these steps, the belief that this was a sustainable strategy led to his downfall.
What are your experiences? Embrace those lessons, share your stories and learn how to overcome these obstacles.