There was a great article in the Sydney Morning Herald on trading and why most traders lose money.  Regular readers know that I focus a lot of time and energy on understanding not only the psychology behind my own trading, but also the psychology of other traders.  General Patton once said: “if everyone is thinking the same then someone isn’t thinking”.  These words are never more applicable than they are to markets.  After all, the name of the game, more often than not, is being in the trade before anyone else expects it.  Markets rarely move where the majority of investors expect them to move.  The article broke down the reasons for losing into 7 different common emotional mistakes:

1. Emotional bias: the tendency to believe the things that make you feel good and to disregard things that make you feel bad. In trading terms, this means ignoring the bad news and focusing on the good news. It’s called losing objectivity; you don’t recognise when things go wrong because you don’t want to.

This is the primary reason why most traders lose money.  I believe it is mostly due to the fact that the majority of investors are generally biased in their thinking.  They are trained to believe that buying stocks is the best way to invest in a market.  They therefore ignore the other side of trades or other asset classes.  This bias generally leads to a permabull perspective (or a permabear perspective for the more pessimistic).  The general optimism of most traders (or pessimism) leads to cloudy thinking.  Learning to be unbiased and flexible are perhaps the two most important rules to becoming a good trader.  Trading one asset class with one directional bias would be like a professional baseball pitcher deciding to throw nothing but fastballs.  You have many options and pitches – utilize them all.

2. Expectation bias: the tendency to believe in things that you expect. In financial terms this means not bothering to analyse, test, measure or doubt the conclusion you expect or hope for. It is also known as the law of small numbers – believing in something with little real evidence.

Focusing too much on the macro picture can often lead to this kind of skewed thinking.  Peter Schiff is a great example.  His macro inflationary theme is likely to be correct over the long-term, but in the near-term he has cost himself and his investors a great deal of money by not being more flexible and being able to adjust to the micro changes in the economy.  I expect this current bear market to persist much longer, but that hasn’t stopped me from being bullish at times during the last 18 months.  The market is a dynamic system and is constantly changing.  Learn to evolve and change with it.

3. The disposition effect: the tendency to cut your profits and let your losses run – the opposite of what a trader should be doing. Making small profits and big losses is a recipe for disaster.

This is almost entirely due to a lack of discipline.  All investors should have rules.  Have price targets and set stops.  Learn to be robotic in your investing style.  If you give your emotions the opportunity to get in the way of your trading I can guarantee you they will.  Hope is not a strategy when a trade doesn’t go the way you planned.  One of the best parts about the stock market is that polygamy is perfectly acceptable.  You aren’t married to any single position.  Learn to “dump” the losers and move on to the next trade.

4. Loss aversion: the tendency to value the avoidance of loss more highly than the making of gain. Losses impact on you more than gains. Because of this you become more emotional when making losses, the point at which a rational decision would save you the most money.

The math behind stock market losses is unfortunate, but real.  A 50% loss requires a staggering 100% gain to break even.  This is one of the reasons why my focus is so keenly on risk management and money management.  I have never experienced a draw-down of more than 15% in any given quarterly period because my risk management is superb.  There are two kinds of volatility in the investment world: upside vol (good vol) and downside vol (bad vol).  Finding investment managers with high Sortino ratios, i.e., very little bad vol, is very rare.  The moral here is to learn asset allocation and the interconnectedness of non-correlated assets and you can in fact create portfolios that are structured to generate high risk adjusted returns while also being nearly invulnerable to black swans.

5. The sunk-cost fallacy: this is the tendency for our decision-making to be influenced by the size of the loss we have already incurred. The bigger the loss, the more likely we are to persist with a losing trade rather than take the rational decision to cut to a more profitable trade. The size of your loss has no impact on the future share price but a huge impact on your ability to make the right decision.

Position sizing is the most important form of risk management.  If you invest your entire portfolio in a handful of high beta stocks you have to be willing to lose an extraordinary amount of money. Regular readers have likely noticed that I have a very patient “lie in the tall grass” investment style.  I often wait for fat pitches, but never ever over allocate funds – even when I feel very certain about a trade.  I always respect the fact that I can and will be wrong at times.  Position sizing ensures that no single position can destroy years of hard work.  Learning to allocate capital across a number of assets while creating a black swan proof portfolio is all about position sizing.  Nassim Taleb wants you to believe that it’s impossible to avoid black swans (which is true), but black swans don’t have to be destructive as Taleb would have you believe.

6. The bandwagon effect: the tendency to think it must be right because everyone else is doing it – a thought process guaranteed to get you in when it’s obvious and get you out when it’s obvious. Put another way, it has you buying at the top and selling at the bottom.

As I said earlier, when everyone is thinking the same, someone isn’t thinking.  Learn to go against the crowd.  And when the boat feels like it’s tipping to one side, jump off or consider moving to the other side.  And never let anyone tell you cash isn’t a position.  If you feel uncertain or uncomfortable pull your portfolio out of the game.  Like blackjack, there is no rule that says you have to play every hand.  For more sophisticated investors cash can also serve as an alternative asset class via currency markets.

7. Past-price fixation: the tendency to avoid prudent trading decisions by anchoring your thought process to prices that no longer exist. “I’ll sell it if it gets back to $4.” “I’ll buy it if it gets down to $4 again.” We are all guilty. In trend-following trading, if the price goes up, you don’t sell it, you buy it; if it goes down, you don’t buy it, you sell it. The old high has gone, the old low has gone. Don’t wait for them to come back to do the wrong thing.

This goes back to being disciplined.  You’re going to lose money.  Deal with it.  The real goal of trading is to make sure your losers don’t mortally wound your portfolio.  Aim for singles and doubles and focus on not striking out.  While home runs are exciting and the idea of finding the next Microsoft is grand and all the reality of it is that you’re highly unlikely to do either.

Good luck out there.

* Thanks to Emilia for the generous donation


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • SRSOwner


  • Tyler


    Great post. Thank you. I went back to your IBD rules posting. What are your rules? Might make for good discussion and alternative insight to IBD.

  • Tyler

    … more … I like the topic of “discipline”. Yes, I have and probably do tend to trade like a loser. I can think of a few examples for sure. More of this stuff would be great. Thanks.

  • http://www.pragcap.com TPC


    I use multiple strategies so I have different rules for different scenarios. I’ll put together some thoughts though for a later post.

  • AndyD

    One of the best pieces you’ve written to date. Nice work here TPC.

  • Brian Wright

    As a life-long student of human behavior, and a full-time professional trader, I’m well familiar with the principles outlined. A significant reason for my success is my unrelenting focus on “trading the traders,” or trading price movements driven by fluctuations in greed and fear (buying the bottoms created by panic selling, and selling the tops created by panic buying), and exploiting exhaustion points (timing). In essence, I’m taking advantage of the psychological mistakes presented in the article, especially in periods of volatility. These traits are so pervasive, and so persistent, that I doubt my business model will ever go without daily opportunity.

  • yo

    Unfortunately, the points you covered are the conventional wisdom to trading success. George Soros goes for the jugular. That’s one of the reasons why he is on top.

  • SRSOwner

    Soros made one big bet on the commodity markets and got lucky. If that trade had gone against him no one would ever know who he was.

  • SRSOwner

    currency markets I mean. TPC you need an edit button.

  • Simon

    Hi TPC,

    My formula:


    I find patience is the toughest part – just letting the trade ride.

    By the way, great post.

    Thank you

  • Nat

    As a fairly new investor (about 4 months now) I can attest to those points. I am a big loser overall and am realizing my failure is “failing to plan a strategy” and my emotions. I hope I take your excellent advice and start over. Thanks for the great piece of advice!

  • Aki_Izayoi

    I think the key to being a good trader/speculator is to know what you are doing. Yes, you are a trader… TRADER!!! Remember, they are TRADES, not free money. Ask yourself why do people take the OTHER SIDE of your trades.

    Another key that I ask myself. Do I have an information asymmetry or lower intertemporal discount rates (allows you to take more short term volatility for long term gains) over other traders? Trading is zero sum…

  • prescient11

    My biggest rule is don’t let fundamental knowledge affect what is happening on the charts. If you trade intraday, trade with a backdrop of knowledge but don’t let it guide you completely.

    And it’s discipline folks, discipline. That should be at everyone’s desk.

    BE WILLING TO TAKE THE LOSS. If you were perfect we would all be millionaires!!

    Great article TPC, look forward to reading your strategies.

  • Will

    Hi TPC

    It is by shear chance that I stumbled across your article;

    “I have never experienced a draw-down of more than 15% in any given quarterly period because my risk management is superb.”

    if those are your true results,
    -I would say it would be prudent to consider increasing your risk say 2 fold.

    -doubling your expectancy/ max drawdown 30%/ x2 losses/profits, etc, etc
    — it seems like you have the wiggle room.

    i’d like to hear your thoughts;


  • http://www.pragcap.com TPC

    Will, thanks for the great comment. I have looked at ways of increasing my risk exposure. As you said, I certainly have the wiggle room. I would likely take on a lot more market correlation which is not something I am fond of, however. Investors love my low vol, low correlation returns. My clients sleep at night and so do I.

    I am actually working on a new strategy that would certainly increase volatility and overall market exposure substantially, but it’s still a bit of a work in progress.

    I’d love to hear your thoughts on doing so. Sounds like you know a thing or two about this.

  • Will


    i didnt realise you were trading in a fund, i can certainly understand taking a conservative approach.

    another way of increasing exposure is;
    -increase no. of trades

    but the practically of this would depend on your market/ timeframe, etc
    -which im sure your aware of

    best of luck;

  • http://stockmarketadvantage.blogspot.com Bob G.

    Good opportunities to trade and have an edge are much more infrequent than most realize. Great buying opportunities come along every 4-5 years in equities. Finding a way to accurately measure the fear level of the masses is one of the keys to know when to scale into the market and subsequently scale out.