Nothing bores me more than cliche trader advice. You know the classics – don’t catch a falling knife but buy when there is blood in the streets. Don’t fade a trend but make sure you don’t chase. Bulls and bears make money, pigs get slaughtered, yet make sure you let your profits run. I mean, really? Trading is so nuanced that it is difficult to articulate any rules that work consistently. The reality is the game is constantly changing and the only surety is what worked yesterday won’t work tomorrow (ok, maybe what worked yesterday will work tomorrow, but you get the idea).
Yet every now and then someone manages to capture the true essence of trading. Recently I stumbled upon a post by Dr. Bret Steenbarger titled “Why So Many Traders Lose” that conveyed so much of the subtle shading that exists in the markets, I felt I had to share it.
From Steenbarger’s piece:
Here are a few observations on why so many traders fail. It’s not because of psychology:
1) The majority of traders think directionally, and they think linearly. That has them trading momentum and that has them trading trends. Even the traders who look for reversals look for momentum and trend, just in a different direction.
2) Market behavior can be described as a combination of cyclical and linear (trend) components over any particular time frame. As markets become more crowded, cyclical components dominate over time, reducing the Sharpe ratio of those markets.
3) Traders fail because they are thinking in straight lines when they should be thinking in cycles. They think of cycles as sources of choppiness and noise, not as sources of signals that are different from linear, trending ones.
4) Any market cycle consists of mean-reverting behavior at cycle peaks and troughs and trending behavior between peaks and troughs. This ensures that any single approach to trading markets (looking for trend/momentum; looking for reversal/mean reversion) will draw down substantially over many cycles.
5) When the Earth was found to be round and not flat, that opened the door to exploration and development of new lands. When markets are viewed as cyclical and not linear, that opens the door to promising trading strategies.
6) A great deal of the emotional frustration and disruption of trading that traders encounter is the result of trying to fit markets into a preferred framework, rather than discovering the framework that best describes market behavior.
7) Becoming more disciplined in applying inappropriate models to markets leads to greater consistency in losing. If a ladder is leaning against the wrong building, becoming a better climber won’t get you to your destination.
In short, traders lose, not because they’re bad at the game, but because they are playing the wrong game.
Pay close attention to point 4, 6 and 7. Steenbarger is observing that markets behave consistently for a period of time, and then change. Traders fail because they refuse to change with the markets.
That is why if you ever come across a trader convinced he has found the Holy Grail, ignore him. Most likely his style is just in mesh with the current environment, and that when the markets change, his ability to make money will disappear.
Thanks for reading,