Before launching into the actual reason traders lose money, let's step back and review an important principle: Most accepted wisdom in the trading world consists of kernels of wisdom that have been blown up into Grand Ideas that are utterly invalid.
The poster child for this phenomenon is the idea of discipline. Successful trading requires having rules that guide decisions and actions. Success requires the consist following of those rules. Given a set of valid rules, the better performer will be the disciplined person who trades with fidelity to those rules. Makes sense.
But once we blow discipline into a Grand Idea and insist that Discipline is the source of all trading success, we then have mentors and coaches who harangue traders with journals and checklists to monitor every minute activity. This ultimately serves two purposes: it makes traders so self conscious that they are no longer attuned to market patterns, and it so routinizes trading that traders become unable to adapt to changing market conditions. As a general principle, discipline makes sense. As a supposed formula for trading success, Discipline ensures consistency in losing.
The same is true for ideas of emotional awareness and mindfulness in trading. Great ideas in context that, once blown into Great Principles, divert traders from the real work for identifying objective patterns playing out in the marketplace. If a trader trades randomness with self awareness, they will be a keen observer of their own demise.
Which brings us to the topic at hand: the real reason traders lose money.
One of those nuggets of wisdom that gets blown out of proportion is the idea that success comes from trading in a way that fits your personality. There is certainly truth to that. If you're an extroverted person, your idea generation is likely to benefit from talking with knowledgeable market participants. If you're introverted, you are more likely to benefit from reflection and analysis. Taken to the level of Grand Principle, however, the idea that success will follow from expressing your personality in markets becomes a kind of anything goes, do whatever you feel like justification for poor decision making.
Because *that* is the real reason traders lose money: They ARE trading their personalities. Show me a losing trader and I'll show you someone acting out their personality in risk-taking. Consider examples drawn from the "big five" personality traits:
* The trader who lacks conscientiousness in his/her personal life fails to achieve consistency in trading. The trader who is overly conscientious fails to innovate when market conditions change.
* The trader who lacks emotional stability in his/her life trades impulsively and emotionally. The trader who is highly emotionally stable has difficulty taking proper risk out of fear of upsetting the emotional apple cart.
* The trader who is highly introverted or extroverted allows internal or external stimuli to interfere with decision making.
* The trader who is highly open to experience becomes so enamored of new ideas that his/her trading becomes skewed by the latest shiny toy. The trader lacking openness to experience finds one way to make money and can't do anything else even after that one way loses its edge.
* The trader who is very likeable has difficulty tuning out people and becomes easily distracted by noise. The trader who lacks likeability alienates the very colleagues that could help inform his or her trading.
In other words, traders lose money BECAUSE they are trading their personalities. Every personality trait brings potential assets and liabilities to trading. Sometimes, our personalities pose severe challenges to trading success. Every personality asset, when overutilized, brings its own set of problems.
There is only one source of making money in markets, and that is identifying recurring patterns in market behavior and exploiting those in a manner that provides solid reward relative to risk. We marshal and attenuate various personality traits to identify and exploit those patterns. Success comes, not from indulging our personalities, but from knowing which traits to draw upon and which to work around. That is called wisdom.
In my next post, I'll provide a personal example of trading success that came, not from following my personality, but from properly channeling it.
Further Reading: Trading Psychology for the Experienced Trader
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