Why Do Most Traders Fail?

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I have been often asked why the vast majority of forex traders, futures traders, and equity day traders are unsuccessful (with success being measured by a minimum of a 2-year track record of profitability)? The answer to this question is multi-faceted, however, the primary answer lies in one word: Leverage. I have read many articles which attempt to explain the reasons why traders fail and they are filled with the usual answers such as: Don’t cut losses short, don’t let profits run, poor trade selection, do not develop a proper trading plan or fail to execute the plan etc. etc. Fair enough, these are all good reasons why traders don’t succeed but excessive use of leverage trumps them all in my opinion.

More leverage requires exponentially greater precision in position entry/exit and timing, it also greatly increases ones exposure to short term market noise. By ramping up the leverage, one is also dramatically ramping up the likelihood of being stopped out or worse yet, suffering a crippling loss.

For example, a 40 pip move (1/4 of the recent average true range of 160 pips) in EUR/USD is only a .3% movement for the currency pair, however, such a move can wreak havoc on a leveraged trader’s P&L. Let’s do some math:

Losing 40 pips in EUR/USD while employing 5-1 leverage = losing 1.5% of account capital

Losing 40 pips in EUR/USD while employing 10-1 leverage = losing 3% of account capital

Losing 40 pips in EUR/USD while employing 20-1 leverage = losing 6% of account capital

Losing 40 pips in EUR/USD while employing 50-1 leverage = losing 15% of account capital

Losing 40 pips in EUR/USD while employing 100-1 leverage = losing 30% of account capital

In the grand scheme of things a 40 pip move in EUR/USD ($EURUSD) is insignificant and is often times rapidly reversed, although it is easy to see that such a move is far from insignificant to a trader employing 100-1 leverage. By the way, these leverage ratios may seem a bit crazy to equity traders and perhaps even to futures traders but they are standard in the world of forex.

Now to futures, for the sake of simplicity I will only focus on the E-mini S&P futures contract ($ES_F). Each point/contract in the E-minis= $50, therefore a 10 lot is $500/point. Let’s analyze the impact of an 8 point (using the same ¼ of the recent average true range of 32 points) move in the E-mini on a 10 lot position in a $100,000 futures trading account:

An 8 point loss on a 3 contract position equates to a $1200 loss or 1.2% of account capital

An 8 point loss on a 5 contract position equates to a $2000 loss or 2.0% of account capital

An 8 point loss on a 10 contract position equates to a $4000 loss or 4% of account capital

An 8 point loss on a 15 contract position equates to a $6000 loss or 6% of account capital

The fact of the matter is that most forex traders are trading much more aggressively than even their futures trading counterparts when account size, position size, and market volatility are taken into consideration. I have never met or heard of a successful forex trader who regularly employs more than 10-1 leverage, perhaps they are out there and if one of them is reading this please feel free to introduce yourself.

Proprietary equity traders also face a stiff challenge as they regularly trade single positions which dwarf their equity capital in dollar amount. This often leads to lots of stop-outs and overtrading. Believe me, I have been there, done that, and witnessed it not only in my own trading but in the trading of many others.

It should also be emphasized that position size should be a by-product of risk which is naturally heavily influenced by market volatility; therefore, in a volatile market position size (leverage) should be reduced accordingly. I believe that it is this simple mistake which vexes most inexperienced traders i.e. continuing to use the same position sizing when market volatility has increased significantly. Equity traders should also be aware of this phenomenon, particularly during earnings season which is fast approaching. After-hours and post-earnings reaction trading can be very volatile – ongoing earnings conference calls and changing interpretation of the news can often lead to sharp reversals.

Finally, the common theme among forex traders/futures traders/prop equity day traders is that they are all attempting to score large profits with generally insufficient equity capital with which to properly achieve their desired results. Why do you think forex brokers are willing to offer 100-1 leverage? It is because their customers seek such leverage in order to swing large positions with the least amount of equity capital possible. Moreover, most forex brokers are taking the other side of their customer’s trades which gives them a sizeable advantage due to the undercapitalized nature of their “counterparties”. Here is a little estimate which I have come up with on my own (feel free to offer your thoughts on this in the comments section):

Percentage of people who attempt trading that eventually become successful (consistently profitable for at least 2 consecutive years):

Proprietary equity trading: 10%

Futures trading: 5%

Forex trading: 1%

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