Why Most Retails Traders Fail To Make Profits on Investments
The statistics on trading make one thing very clear: there are very few winners in this game. 70% of retail traders fail to make a profit in the first year of investing. As much as 96% of all Forex traders lose money and exit the market. There are some reasons why the rate of success in retail trading is so low. Here’s a look at some of the important ones.
Brokers are the main gatekeepers in the retail trading ecosystem. They use that position to levy service charges in exchange for investment advice, which is what is referred to as a commission. Considering that commissions made from client transactions are a prime source of income for full-service brokerages, they’re equally a source of losses for individual traders.
Seeing how commissions can eat into traders’ returns, there are services that now offer robo-advisors and discount brokerages. Although the fees involved in using these are significantly lower, they fail to provide to tailored investment advice that an investment advisor would. Traders are therefore forced to choose between high commissions on the one hand and a lack of personalized investment information on the other.
Retail Brokerage Advantages
While brokerages derive profits from client transactions, they also hold an advantageous position within the market. These institutions can leverage price feeds aggregated from various banks and similar liquidity providers. Individual traders do not share that advantage and are forced to pay retail prices rather than the wholesale prices on which brokerages trade.
In addition to having access to price feeds, brokerages can also use client flows to inform trading decisions. They can go one of two ways with this information. On seeing a majority of clients trading in one direction, brokerages could join them if they’re trading as principal. They could also go in the opposite direction if historical data suggests that clients tend to be wrong in certain situations. Individuals traders contribute to this advantage that brokerages possess, but reap none of its benefits.
Algorithmic and High-Frequency Trading
Like most things, trading is a practice that is helped by the use of computers. Specifically, computers can be used to execute trades based on a particular set of criteria. These criteria depend on factors such as price and timing, which are codified into an algorithm.
Programmers can use these mathematical models to write software that automates trading decisions. This gives them the ability to return profits at a frequency that human traders cannot achieve. Algorithmic trading also eliminates the emotional biases that sometimes creeps into trading activities.
High-frequency trading is an evolution of algorithmic trading in which software programs are used to study multiple markets simultaneously. The data obtained from these analyses are used to make orders in very short bursts of time. High-frequency trading firms often locate their servers close to exchanges to minimize the time it takes for information to flow between them. Individual traders who don’t possess the resources create such software find themselves competing from a disadvantaged position.
When an individual buys a commodity, it is because he believes the investment is worth the use derived from it. For example, you might buy a car because you think it would be the most comfortable way to get around town. But when you invest in a financial asset in a market of your choice, it’s not because you find it useful. Rather, the investment is made with the expectation that the asset’s value will change over time.
This shows that financial markets work on information arbitrage. Individual traders often underestimate the research costs and time involved in making informed decisions around an order. Even when they do all the due diligence, traders are at a disadvantage against institutions such as banks and brokerages, which have access to a greater volume of insightful data. This information asymmetry is a major reason why most traders find it hard to make profits from their investments.
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