Trading is not easy, and many first-time investors lose out. That is exemplified in the well known 90% rule.
Log onto any trading website, and you will see attractive graphs and figures espousing the possible returns on investment that await. The truth is that trading is tough, and many newcomers actually lose money. This is exemplified in the 90% rule. But what does this mean, and how can novice traders avoid this?
The Rule of 90%
The rule of 90 suggests that 90% of new traders lose around 90% of their starting capital within 90 days. It is unknown where the figure comes from, and there are really no statistics to back it up. It comes from years of academic research, experience, and heartache. It remains due to its harsh truth, which is that trading is something that needs to be taken very seriously, especially when it comes to possible losses.
Why Do 90% of Traders Fail?
The first reason is that many people who engage in trading have expectations that are far too high. They are fed a narrative of quick wins and overnight riches. This isn’t the case. While experts who work on Wall Street and the London Stock Exchange may do so, for those on the outside, trading is often a much longer slog. Gains are often made over extremely long-term investments, often totalling 20 or 30 years. Even then, it can result in losses.
Alongside this often comes a lack of a solid plan. Fresh traders often go in with solid entry and exit plans, with stop losses and profit-taking levels in place. They also need to have an idea of their risk tolerance and if they are looking for short or long-term trades. Testing these plans is just as important as enacting them. A quality trading app will have ghost accounts that you can use to get this right, and also let you experiment with different trade types like forex without risking your capital.
Lastly, emotional trading is one of the common faults that new investors make. This involves making moves based on the heart, not the head. It may involve making a trade out of boredom, jumping on the fear of missing out bandwagon, the hope to make a quick buck, and just plain old greed. People may also become invested in companies they have emotional attachments to. It may be sports clubs or local businesses. None of this is a good idea.
Leveraging
Leveraging is a trading tool that allows you to open a position with more money than you deposit. You do this by lending money from your broker, so that you can multiply your position by 5, 10, 20, or even 30 times the amount. However, the broker does not loan you this money for free. Instead, you have to lay down a deposit, known as the margin. The amount of margin is known as the leverage ratio. It can be used on a wide range of trade types, from stocks and shares to forex and indices.
Leverage seems like a great idea to new traders. Yet it isn’t, especially when trades become overleveraged. Just a few small moves can become huge losses as you cut into deposits you have made. With leverage, you leave very little room for error, which is the bread and butter of stocks and shares. They naturally rise and fall.
Avoiding the 90% Rule
Avoiding the 90% rule is no easy feat. In fact, even with sage advice, you may still fall prey to market forces and just bad decisions, which everyone makes. There are some tactics you can use to avoid it, though, or at least reduce these initial losses.
The first is to thoroughly do your research. Never invest in a company based on speculation. Look at its current and previous prices. Check out the news about it in the media and the industry. Does it seem like it will grow, or is it one that has stagnated? From here, dive into the financials and internal documents.
Once you have this, form a trading plan. This should include how much you plan to put in, what your stop losses will be, and when profit taking will occur. Having a concrete plan will hopefully protect you from making decisions based on emotion.
Start small. When you have large positions, it amplifies both gains and losses. This brings more emotion into the equation, which can be dangerous when you are inexperienced. Keep a journal of your trades, and learn from them. As it progresses, you can begin to invest more money and make larger trades.
Trading is not gambling. It follows quite predictable patterns, and if you do the work, you will be able to see when to enter and exit. It is also not just those working in finance who can benefit. Yet it does require a strict and managed approach, one that does not search for quick gains but is a long-term strategy.
