Why most traders lose

In short

A friend of mine opened a trading account with a thousand dollars and a head full of stories. You may know someone like him, or you may be looking at the same screen yourself. If so, the first thing to know is that the cards are stacked, and not by a villain. Every trade has a cost, and costs eat small accounts. Write down what you pay per trade before you make one. Add up the fees, the spread, and the tax, then ask if your edge is bigger than that bill. Decide your loss limit before you enter, and keep it when your gut says otherwise. If you cannot explain why you expect to win, you are guessing. Guessing is fine for fun money. It is a poor plan for rent money.

The whole of it

What it is

You have probably heard that most traders lose, and you may have wondered whether it is true or just a scare line. I once heard a fellow at a feed store say it with total confidence, and I could not have told you where he got it. So let me be careful. I will not hand you a percentage I cannot source. What I can tell you is that regulators have looked at this question and have published what they found. In Europe, the European Securities and Markets Authority requires firms that sell contracts for difference to warn customers about how many of their retail accounts lose money. In the United States, the Securities and Exchange Commission and FINRA both publish investor warnings about day trading. FINRA's page on day trading risks says plainly that day traders should be prepared to lose all the money they put in. Those are worth reading in their own words.

Trading here means buying and selling over short stretches, hoping to catch small moves. It differs from investing, where you buy a piece of a business or a fund and wait. Both involve risk. But the trader pays the toll booth again and again, and the toll adds up.

You deserve a clear picture, and you are plenty capable of understanding it. Nothing here says you lack talent. It says the game is built so that talent alone is not enough.

How it works

Picture a poker table where the house takes a small cut from every hand. Even if all the players are equally skilled, the pile of chips shrinks a little each round. That cut is the cost of trading. It shows up as a commission, as a spread, and as tax.

The spread is the gap between the price a buyer will pay and the price a seller will accept. If a stock shows a bid of 20.00 dollars and an ask of 20.05 dollars, you buy at 20.05. You could sell right away, but you would get 20.00. You start every trade five cents in the hole. Do that many times a day, and the small holes join up.

Then comes the other side of the ledger. Someone is on the other end of every trade you make. Some of those people are large firms with faster computers, better data, and teams of people who do this all day. You are not stupid for finding that a tough match. Anyone would.

Then there is your own head. A loss stings more than a gain feels good, and that pain nudges people to hold losers too long and sell winners too soon. I have done it myself with far smaller stakes than money. Hope is a comfortable chair, and hard to leave.

The numbers, and where to find yours

Your own costs are the numbers that matter most, and you can find them without asking anybody. Your broker's fee schedule lists any commission per trade. The spread shows right on your trading screen as the bid and the ask. Your tax bill depends on how long you held each position and on your income.

In the United States, gains on things you held for a year or less are taxed as ordinary income, and gains on things held longer get a different rate. The Internal Revenue Service explains this in Publication 550, Investment Income and Expenses, and in Topic 409 on its website. Your brokerage sends a Form 1099 B each year that lists your sales, and that form is a fine place to see what your trading truly did.

The wash sale rule matters too. If you sell at a loss and buy the same thing again within a window set by law, you may not be allowed to claim that loss right away. The window is the current figure, which the official source publishes each year days on each side of the sale. Check IRS Publication 550 for how it works.

If you borrow to trade, the interest rate is another number to find. Your broker sets a margin rate, and it is listed on the firm's site. Pattern day trader rules also apply to some accounts, and FINRA sets a minimum equity of the current figure, which the official source publishes each year for those who trade often on margin.

A worked example

Let me tell you about a woman named Denise. She is a dental hygienist, careful and sharp, and she decided to try trading with 5,000 dollars of her own savings. She made 200 trades over the year, each about 1,000 dollars in size.

Say her broker charged no commission, as many do now. She still paid the spread. Suppose the average spread cost her 0.10 percent of each trade, once on the way in and once on the way out. That is 0.20 percent per round trip. On a 1,000 dollar trade, 0.20 percent is 2 dollars. Over 200 trades, 2 dollars times 200 comes to 400 dollars.

Now suppose her winning trades and losing trades were a perfect coin flip before costs. She would break even on paper, at zero. After costs she is down 400 dollars. On a 5,000 dollar account, 400 divided by 5,000 is 0.08, or 8 percent. She needed to earn 8 percent just to come out even.

Now add tax. Suppose Denise made a few good trades, and her gains on those came to 600 dollars, all held under a year. If her tax rate on ordinary income were 22 percent, then 600 times 0.22 equals 132 dollars owed. She cannot always use her losses as neatly as she would like, especially if the wash sale rule applied. So she could owe tax on gains while sitting on a net loss. The 22 percent here is my plain figure for the example, not a rate to rely on.

Denise did nothing foolish. She simply met the math. Her story is not a warning about her. It is a picture of how the toll works.

Where it goes wrong

You have likely seen a screen full of green numbers and felt your pulse pick up. That feeling is the first trap. A few wins in a row can feel like skill when they may be luck. It is hard to tell the two apart with a small sample.

The second trap is size. People risk too much on one trade because the payoff looks big. One bad day can then wipe out a month of small gains. Keep your loss on any single trade small enough that you can shrug it off.

The third trap is borrowed money. Margin can make a gain larger. It makes a loss larger too, and your broker can sell your holdings to cover what you owe. That can happen fast and without a friendly phone call.

The fourth trap is chasing. After a loss, many people trade harder to get the money back. That is tired thinking, and it costs. When I feel that itch in any part of life, I step outside for a walk.

Last, skipping the records. If you do not track what you paid and what you earned, you cannot know if you have an edge. Keep a simple log. It is humbling. It is also honest.

Questions to answer before you leave this page

Can you say, in one plain sentence, why you expect to win over many trades and not just one? Do you know what you pay in spread, fees, and tax on each round trip, and have you written that figure down? What is the most you are willing to lose on a single trade, and the most you can lose in a month, before you stop and think? Is the money you plan to use money you could lose without missing a meal or a bill? Have you read the investor warnings from the SEC and FINRA on day trading, and what did they say that surprised you? If you are using borrowed money, do you know your margin rate and what happens if the account drops? And when a trade goes against you, what will you do, and have you decided that now while you are calm?