Why Day Traders Fail (Avoid The Pitfalls)

Last Updated on June 11, 2021 by Oddmund Groette

Day trading certainly holds promises of a fast-paced working environment with high returns. Its allure proves practically irresistible to many new traders. It is also a common belief that most day traders don’t make much money, and many more are even confronted with the possibility of losing their trading deposits in a single year. This begs the question:

Why do so many traders lose money? This article explains why day traders fail and what you can do to survive and perhaps prosper. New traders don’t understand the ecology of the markets, have no game plan, trade too big, and don’t know their risk tolerance. 

How many day traders are losing money?

Just a few day traders make profits, as most traders become the prey, instead of the predator. How many of them out there are losing money? There isn’t an exact answer, though likely no less than 90% will have fallen under that category, whereas only 1% are likely to be out there “making a killing”. Sadly, this also happens to make a lot of sense. Why?

The ecology of the markets

Due to its competitive nature, day trading could more or less be seen as a zero-sum game. The same thing happens in poker – not everyone is going to end up a winner. 

You must understand the market and its players first. Who are your rivals? Who are the predators? Compare day trading to long-term investing. Since the end of the second world war, the US Stock market has gone up 6-7% in real terms. And why is that? That’s because it is not a zero-sum game in the long-term. Companies earn money through increased profits and the US Treasury keeps on increasing the money supply. It’s hard NOT to make a decent return as long as you have a diversified portfolio. By simply being patient and building a stock portfolio, you’re increasing your chances of making a profit. Alas, this isn’t very exciting, and it won’t happen overnight. Most new traders can’t wait to make that first buck.

Few day traders use quantified strategies

The main reason why most day traders fail is that they start day trading without a trading edge. They’ll need an edge to succeed. Having a trading edge means that your trading setup has a higher possibility of being successful, which can be translated into a greater than 50% chance win rate, or you make more from the winners than the losing trades. Quantifying in day trading becomes even more important once we consider the sheer amount of noise and randomness.

Having a strategy for day trading often feels like a daunting task. Trading always takes uncertainty into account. All trading decisions have a financial impact. Therefore you need to find your own trading strategy. Your best option is to use a step-by-step approach on learning how to build a trading strategy that’s completely separate from discretionary trading.

If you are unsure where to start, you might want to subscribe to our Trading Edges. Once a month we share a simple quantified backtest that you can either use or improve yourself. Some of the Trading Edges are day trades:

A day trader needs a trading plan

Regardless of your trading style, having a trading plan will prove to be the key to your success because day trading requires both foresight and strategy. Once you look at day trading as a day job, you’ll realize the importance of having a trading plan in advance and avoiding the common issues experienced by new traders: not having a real game plan for what and where to buy.

Your trading plan should cover every aspect of the trading process. You must know which market you want to trade, which strategy you want to use, and what kind of trade management technique to use. It would help if you also considered which time frames to use, be it 15 or 30 minutes to an hour, perhaps testing strategies outside the regular trading hours. You should also have determined a proper position and have clearly defined risk parameters.

Follow your passion -not money

Day trading is often defined by its scalability – its ability to make money fast. That is what attracts beginners, which honestly makes little sense. Without passion, you’re bound to lose. You must first love what you do and then detach yourself from the outcome.

Day traders should trade small

Another way to increase your losses is to trade position sizes that are too big for your account. New traders usually do this as they attempt to increase their potential profits, since the regular price movements in the intraday timeframe are seemingly too small to offer them any reasonable profit. They’re missing the point. A single trade won’t be enough to increase their profits. Success always requires consistency which you achieve by building up some small, but frequent, profits over time.

Day traders must understand their risk tolerance

It’s important to understand your risk tolerance level. This is a lesson that beginners tend to learn through sheer experience. Why is that? One of the most important things in trading is to detach from money. That is difficult if you don’t understand your risk tolerance. Trading too big, and you will most likely not follow the plan. How significant drawdowns can you suffer before you lose faith and give up?

Day traders need to be patient

New traders rarely take their time to learn. They start trading believing that profits are made instantly. They want to start trading before even understanding the difference between a pullback and a trend. They barely have a grasp on market changes. It’s not uncommon to see new traders rush to bet their money in the market without knowing anything about the trading process. They still believe trading is an easily acquired skill. They’re not traders, they’re gamblers.

Trading requires more than just hard work, it also requires time, study, and numerous failed attempts before it ever becomes successful. Even after learning the basics, experienced traders still dedicate themselves to developing new strategies.

Some day traders do it for the thrill

Some day trade for the excitement. While achieving success can be exhilarating, you can’t make money without preserving your capital. As Warren Buffet puts it, protecting your trading capital is the number one rule.

Not knowing when to close a losing trade can amplify a loss dramatically – a small loss grows into a big one. Losses make it harder to make a comeback. If you lose 50% of your capital, you need 100% to get back to even.

Day traders need to adapt constantly

New day traders have a hard time adapting their strategies to an ever-changing market. They rather stick with whatever strategy that works for them, believing it will continue to do so indefinitely. No single trading strategy lasts forever. Some are designed for a range-bound market and other for a trending market. As soon as market conditions change, a trader should be smart enough to choose a more favorable strategy. New traders would be wise to have more than a few uncorrelated techniques and strategies up their sleeves.

Lacking the mindset

Day trading is more than just creating strategies and developing criteria, it’s also about controlling your emotions and how they affect your trading. Hope, anger, despair can affect how your trades. Moreover, we carry many biases with us. Loss aversion, anchoring, confirmation bias, “resulting”, etc. are just a few of them.

Make sure you survive

Many only move to day trading when they’re looking to make a quick buck. Trading is about protecting your capital so you can live another day to trade. If you’re spreading a quarter of your investments with each new trade, then you’re not going to survive for very long. A few losses will be enough to take you down.

Day traders force trades – why day trade?

Many traders start by having a goal of making, for example, five trades per day. This is, of course, the wrong approach. You can’t force trades, you need to take what the market offers. If you can only find strategies that trade on average two times per day, then so be it.

We suggest you widen your horizon and include trades that might last over many days – swing trading. A trader needs to be agnostic and open for all opportunities that the market offers. 

Day traders make trading complicated

It was Robert Pretcher who said that most traders ruin a good system by trying to make it perfect. The future is rarely the same as the past, thus the pitfalls of curve-fitting are always present, no matter how tempting it is to fiddle with the strategies to make them perfect. A simple system, with few variables, is likely to last longer than one with many variables.

In the end, what is the difference between a good and a bad day trader?

Make sure you are the predator and not the prey, and use the ecology of the markets to your advantage. Accept that losing trades are part of the game, thus you need to control your losses. Make sure you have a plan and only trade strategies that are backtested and quantified, and that you are diversified in terms of trading many uncorrelated strategies. Use the law of big numbers to your advantage and detach yourself from money and the financial outcome.