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Mar 1, 2021, 10:41 AM GMT

Why So Many Traders Fail?

New York Stock Exchange Trader

There is a well-known adage that 'over 90 per cent of traders fail on the market', which may not be factually true, but it elucidates a grim reality. Most newbie traders are bound to face overwhelming hurdles at some point in their journey to becoming consistently profitable. Whether it be an inability to tweak their risk management strategy or difficulty finding the best entries and exits plan, it is a fact that most traders struggle to strike the right balance. But why is it so hard for people to adopt a proper trading mentality, and why is there no established path to that end?

As is often the case, the answers to these and other questions related to human nature can be traced in the natural sciences. It is worth viewing the theory of evolution to discern why people are so ill-equipped for trading.

Everybody has heard about Darwinian natural selection, and the common perception (or rather misconception) is that it postulates a 'survival of the fittest' model. At first glance, this term seems quite fitting for describing the market's reality - a highly competitive environment where only the best traders make it. But therein lies our problem. If the key to consistent profitability is to become a better-fitted trader, why is it then that so many traders fail consistently, regardless of how much extra preparation and education they get?

Another captivating term snatched right from a biology book that can be used to describe trading is 'The Selfish Gene'. In fact, the term was coined by Professor Richard Dawkins in his seminal book bearing the same name. The selfish gene theory relates to the survivability of certain types of genes by means of making copies of themselves in subsequent generations (reproduction).

While the popular misconception will lead you to believe that it is "only the strongest" genes that make it to the next generation, Professor Dawkins explains that it is rather, to put it simply, the genes that make the individual most secure that have the greatest chance of reproducing. That is why early humans did not evolve to become the strongest, fastest, and most agile predators on the planes of Africa, but rather developed large brains that helped them protect themselves against such vicious predators. This has huge consequences for the 21st century equivalent of those African hunting grounds that are the global capital markets.

Humans developed brains that are programmed to recognise patterns. Proponents of the social Darwinism misconception, such as a certain tyrant from Austria who grew to notoriety in the mid- 20th century, falsely believe that early humans developed those pattern-seeking brains solely to become better hunters. This is inlined with the superman (ubermensch) ideological hypothesis. In reality, early humans needed to be able to spot potential threats that could just as easily be hiding in those bushes.

To put it even more bluntly, our brains are programmed to recognise the pattern of a lion waiting in ambush, alerting the individual of imminent danger. The selfish genes become so well-adapt at recognising risks here and there that our brains started doing so even when there is no danger at all. From a Darwinian point of view, it is better to misidentify a lion in the bush but run away to safety rather than wait and contemplate on what you just saw just as you are about to be eaten.

In short, evolution equipped us for survival. Misidentification of shapes and forms is an evolutionary by-product of this early alert system, which is what hinders traders of today. Just like our terrified ancestors on the African planes, traders today are compelled with having to discern what kind of 'animal' is lurking in the chart - is it a Double Top, or is it a Head and Shoulders? Is it a new swing high, or is it a Dead Cat Bounce? And while every trader technically knows what he or she needs to be looking for, our brains are strikingly bad at recognising even simple patterns.

Think about it this way. You are a contrarian trader looking for a break in an existing uptrend. You are on the lookout for anything that may signal an imminent reversal, and yet, subconsciously, you are aware that if you get it wrong, you will end up losing money. Your risk-averse brain, therefore, is more likely to make you overlook that emerging Head and Shoulders Pattern, lest you fail to capitalise on it and end up losing money - the modern-day equivalent for a trader of getting eaten by a lion.

Our own cognitive alert systems seldom hinder us from seizing the right opportunities on the market, which is exactly why so many traders fail. Every time you set out to find the next best opportunity, you are literally trying to overcome thousands of years of evolution. That is not to say that people cannot make money, obviously, but it is exceptionally difficult for people to realise that their perceptions of what trading is may be entirely false.

The problem starts with the false idea that trading is about winning or losing. When you adopt a "winner gets all" mentality, you are unconsciously triggering your brain's survival mode. And your brain will almost always favour not losing (surviving of the selfish gene) money over making more money (survival of the fittest). That is why the most successful traders are the ones who care about being consistent in their actions on the market, and they end up making profits as a result of that.