Weekly Lessons

Do 90% of Day Traders Fail simply because of Not Understanding Technical Analysis?

March 3, 2019

Technical analysis is only one part in day trading.

You can master technical analysis all you want and you still won’t be successful.

Because the market is unpredictable we trade with a set of odds. We know that we will lose trades every now and then or even lose more often than we win.(yes, you can still make money even if you are wrong more than you are right)

The problem comes with not having tested your odds. This leaves a beginner in the dark. Now when a trade doesn’t go their way, they think that the technicals must have been wrong. This in turn starts creating doubt in the next entry. Another loss maybe. Now they see that if they approached it in another way that it might work. Next trade comes and they’ll try the new approach and it doesn’t work… now what…
This is the issue with most beginners.

They fall pray to emotional involvement in a trade and don’t look at the bigger picture. It’s not about winning every trade. It’s about making sure that your money management is set correctly according to the instrument you are trading. It’s about then testing your system to validate odds and spot weakness in your system, then fixing it accordingly to what you feel comfortable with. Even after all that is done, you are still not going to succeed unless you have the discipline needed to manage trades as they run, to have screentime to spot opportunities in and most importantly, have gotten used to the emotional roller-coaster that is live trading.
The Pareto Distribution

The tendency for 5–20% of a profession’s players to generate 80–95% of the profession’s value is not unique to trading, or even to business. It’s known as the Pareto Distribution, which is the tendency in life for a small number of inputs to account for a very large number of outputs.
A tiny percentage of songwriters write the vast majority of hit songs (consider Max Martin as an example), 20% or less of a company’s sales people often generate 80% of more of the sales, a small number of hockey players score most of the goals, a small percentage of people hold the vast majority of wealth in the world, and less than 10% of traders (probably even less than 5%) generate almost all of the profitsA tiny percentage of songwriters write the vast majority of hit songs (consider Max Martin as an example), 20% or less of a company’s sales people often generate 80% of more of the sales, a small number of hockey players score most of the goals, a small percentage of people hold the vast majority of wealth in the world, and less than 10% of traders (probably even less than 5%) generate almost all of the profits
Because of this tendency, 80–95% of the players in most professions are left to fight over the remaining 5–20% of the value.

It’s not surprising, then, that 80% of entrepreneurs who start businesses fail within the first 18 months, according to Bloomberg, and 87% of real estate agents fail after five yeaers in the industry, according to a NAR report
Opportunity Cost vs Direct Cost

“In a zero-sum game, the problem is entirely one of distribution, not at all one of production.” -Kenneth Waltz

When a seasoned professional real estate agent wins business over a newer, less experienced real estate agent, he takes away potential income that the newer real estate agent could have earned. This loss of potential income is known as opportunity cost.
New traders do not have the luxury of paying their market tuition in this way. When an experienced, professional trader wins over a less-experience trader, the newer trader not only pays in the form of opportunity cost like the new real estate agent, but he also pays a direct cost because the experienced trader takes money directly out of the newer trader’s account in order to earn a profit.
This would be like starting a grocery store next to a Wal-Mart, and everytime the Wal-Mart sold a grocery item, the price of the item was taken from your business’s bank account instead of Wal-Mart’s customer’s bank account.

This vicious, added burden of direct costs on new traders makes the failure rates in trading more pronounced than in other professions, and also speeds up the failure process of traders relative to other fields.
Dunning Kruger Effect

“If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.” – Warren Buffet

“To ask the question of whether or not you are operating within your circle of competence is to answer it.” – Charlie Munger

With the deck stacked so heavily against new traders, and the failure statistics so popular, you may wonder why so many people still attempt to trade and expose their hard earned money to such a ruthless game.Are 80–95% of traders just plain st_pid? No. The answer is best explained by a psychological principal known as the Dunning Kruger Effect.The Dunning Kruger Effect is the tendency for people with low ability or low competence to greatly overestimate their ability because they are not competent enough to even recognize how incompetent they are.

In other words, new traders don’t know what they don’t know. And they don’t know a lot. They therefore greatly overestimate their ability to trade, and willingly march to their trading demise in droves.Ultra-Low Barriers to Entry

Imagine facing a life sentence for alleged murder, and having an attorney whose only experience in law is watching a few YouTube videos on the subject.

Or imagine laying on the surgery table and just before your procedure your surgeon says, “Don’t worry, I’m an auto-mechanic by trade and haven’t gone to medical school, but I watch medical documentaries and have read three eBooks on this exact procedure. You’re in good hands- I got this.”

Trading is no less a complex, specialized discipline than law or medicine. Yet there are hardly any barriers to entry for anyone to pass before jumping in.You go to Car driving school, and take course where you are taught every technical aspect of driving in a classroom(it’s a training without actual car driving experience, hypothetical example). Once done you are with classroom, you are given further training in a simulator and you get a license ). Now fully equipped, you decide you can take your brand new sedan on the roads to drive. How successful will you be? If you are lucky, you may end up with few scratches on the car. Now a friend comes and tells you that normal sedans don’t work right with the learning, you need powerful car like an SUV or a Sports Coupe and the training works good with it. Now you may endanger your life or someone else or you may badly damage your car.Compare the above example with someone who learns technical analysis and enters the stock market after making money using a demo account. He starts with stocks(normal sedans ) and get hurt either a bit or more. So was it understanding of technical analysis. No not at all. Technical analysis is just 15–20 % of trading. The important aspect is Risk Management, Money Management and psychology of trading. When anyone starts with stock market, it is basically gambling. When you use technical analysis, you work with charts and become a speculator. The journey from speculator to trader is when you have risk management, money management and trading psychology in place.The most important aspect is you in trading and your own self. With technical analysis you increase the probability of winning trades, but you can’t win everytime. You win some trades you lose some. Your losers should be capped as per you risk management, and you should let your wins runs. People do the opposite and let their losses run and wins are capped. Even with the best strategy in place, you end up with such situation where a position you hold moves into profits only to reverse back and hit your SL. This impacts you such that next time you you book your profits and the wins run. You end up in this vicious cycle till you run out of money. This is one example. There might be more.One more example is indicator paralysis. People are taught price action, patterns, support resistances, uptrend line, downtrend line, trend following indicators, oscillators in technical analysis. This is so overwhelming that a beginner instead of applying his learning slowly and steadily, feels he has found the holy grail to make money. The risk management and money management taught are ignored and instead of baby steps starts with giant steps when he gets lucky in the initial trades and also when he loses to make up for his losses. In this path he tries to Google and learns more on different indicators and keeps moving from one indicator to the other only to be more confused and more losses. It was never the indicator it was you.This is also reason why good traders at big investment firms lose money as well when they start trading independently. In big firms, they have systems in place for risk management and money management. And your trades are regularly audited to your risk levels. There is no way you can skip the process.(though there are instances where traders have caused big losses to their firms). When actual money is on the line, like in trading your emotions affect you which won’t happen in other profession. It’s like you are sitting on cash and someone comes and takes it from you with your knowledge and you can’t do anything about it.So does technical analysis work? You never know unless you give it a try. It gives a trader some data to work with and speculate without which he is just gambling. It increases your probability to win. Trading is all about probabilities. If trade goes in you favor, let it run. If not cut your losses.

Look at technical analysis as your college education. You have learnt a lot but are not job ready. Then when you start trading, it’s like your first job. You don’t become senior management or CEO in the first year. Give time to learn and apply with proper risk management in place. Keep learning more of trading to get an edge which will increase your probability of wins. This is similar to adding skills/certification when you working.

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