Tag Archives | risk of ruin

Why Traders Fail

I've previously blogged about the Risk of Ruin and why so many new traders go broke before having a chance to learn much about the business. 

It's not always about going broke.  Many traders try to make money for a long period of time before giving up.  It's not easy to become a profitable trader.  In addition to learning that which must be learned, there's the perpetual problem of fighting bad habits or allowing certain personality traits to get in the way of making sound trade decisions.

Basically, there's a lot of things that can go wrong which destroy a person's chance to become a successful trader.

In a recent interview with independent trader and blogger, Mark Miniervini, Charles Kirk (The Kirk Report), Charles asked this important question, and received a very helpful answer:


Kirk:  Why do you think most traders fail?

Mark Minervini:  Here are 6 reasons:

  1. Poor selection criteria; usually based on personal opinion, theory or tips and bad advice

  2. They don’t stick to and commit to an approach; style drift

  3. Don’t cut losses (#1 mistake made by virtually all investors)

  4. Don’t know the truth about their trading – they fail to conduct in-depth post analysis

  5. Treat trading as a hobby and not a business

  6. Want too much too fast; learning a skill takes time


There's a lot of important meat in those few lines of text.  We all recognize that it's not easy to cut losses, but I firmly believe that this results in more grief for traders than anything else.  What causes a trader to suffer a big hit?  I believe that it's the unwilligness to accept that a trade is not working, and that it's not likely to get any better if held longer.  Under those conditions, losses mount.  The only way to prevent that big loss is to cut it off at its knees – and the time to do that occurs when it's a much smaller loss.The difficulty with that is sacrificing the possibility that the trade would turn profitable.  My advice:  Get over it.  Many trades will be unprofitable.  That's a fact of life for a trader.

I understand that on a rare occasion a gap opening may do irreparable damage, and not provide an opportunity to take the small loss.  However, that's also a preventable occurrence.  If the damage is too great, then the position was too large.  It really is as simple as that. 

Mark's tips above and my comments may seem simple.  That's because they are simple – and that simplicity makes people doubt their importance.

How many of us look at trades after the position is closed?  How many dissect the entire trade in an attempt to find out what was done correctly and what mistakes were made?  Very few. 

A mistake is not a trade that loses money.  A mistake is making a decision that was clearly incorrect at the time, but the trader was unable to see that.  Another mistake is avoiding a trading plan and not doing postmortems on  your trades.  It all takes so much time.  However, if you take trading seriously, and do not consider it to be a hobby, there's work to be done.

Mistakes are part of the game.  Making the same mistake repeatedly is not.  At least it's not part of any successful trader's game.



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Trading Iron Condors as a Source of Income


Earlier question by Joe:

I'm reflecting on the question asked by GW and your response.
If ICs are deemed income trades then how would one generate a
reasonable income on only 10 ICs a month? 
So would you say trading much larger whilst carefully managing risk with
added protection unwise?

Joe: I amended the reply to include this:  Apparently I missed the point.  I do NOT believe that traders should limit their position size to trading 10 IC at one time.  I hope I never said that.  I believe that's a large position size for a beginner, but not for the experienced trader.

My question (which may have been phrased incorrectly) was pertaining to
trading ICs to generate regular income on a consistent basis.

I think I
may have taken your response out of context as I assumed you were
advocating to trade no more than 10 ICs. So to be clear I don't disagree
with your overall thoughts on ICs as income trades but would still like
to know your view on trading ICs in much greater size with good risk management, in order to generate a greater income.

I ask as I have read
and heard from varied sources that there are traders who do this each
month and therefore would like to know if you think it's a feasible way
of trading?

Yes, it's feasible.

But that's not the same as saying that it's a good idea for most traders. in my opinion, to trade on a scale large enough to generate a steady (not every month, but on average) income that is large enough to replace working elsewhere to earn a living, translates into being a
professional trader.

Why did I jump to trading for a living
when all you asked about is making extra income?  If you plan to trade
size, and if you plan to manage positions carefully, you cannot be
working at a full time job.  At least not when the markets are open.

I don't have real statistics, but I am told by sources I believe to be reliable that 'the average trader never makes any money.'
If that's true, then trading is similar to other professions. Only a
few play sports well enough to become professionals and earn a living. But many play as a hobby, on weekends.

It's easier to make a living as a trader than it is to play in
the NFL – but it's still difficult. 
First prove to yourself you can consistently be profitable. If you
believe you have already proven your skills as a risk manager, and
if you believe you have the discipline, then yes, it's feasible to earn a
living. (Or extra income).

Just remember that earning 20%/year doesn't seem to be a great achievement when you see all those Internet ads telling us how easy it is to earn 5 to 10% per month – guaranteed. [Notice to all readers: Those claims are false]  But you know that 20% is an excellent return, especially over a multi-year span.

And yes, you can earn 50% per year and more.  However, the risk required to earn those returns makes it highly likely that you would eventually lose every penny of your trading capital – if you sought such returns.

The key to earning a living as a trader – in my opinion – is to decide how much income you need, remembering that a significant portion must be saved to pay taxes.  Next, come up with an annual return that you believe is realistic for your trading style and current skills.  Keep in mind that your original plan is to manage risk well.  That must include trading fairly conservatively because you cannot afford a large drawdown.  Then calculate how much capital is needed to generate the cash required, assuming your rate of return is realized.  Then get some extra capital for safety.

Conclusion:  If you have a track record of profitability, if you can raise the capital, if you maintain your discipline and not get flustered when you are suddenly trading more size than ever before, then yes -you can earn a living as an iron condor (or other) trader.  

One caution:  Increase size gradually. Do not move from 10 to 50-lots overnight.  Do not then jump from 50 to 100-lots (or whatever your size turns out to be).  Always keep cash in reserve – because you may need that cash for adjustments at a moment's notice.

Joe, the most difficult part to remember is that being a successful professional anything requires skills and practice.  It is feasible.  That is not the same as 'anyone can do it.'

The one warning that I want to mention is:  Do not make any attempt to do this if you are under-capitalized.  It adds too much pressure. If you start to lose – even a little, then you are going to have to try to earn money at a higher return to compensate for having a smaller account.  And Joe, you know that means increased risk.  That in turn increases the risk of ruin.


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Risk of Ruin. An Unpleasant Topic for Traders

This post recently appeared at OptionsZone.com, where I am a contributor.  Take a look at Options Zone – you will discover options articles of interest.


For some, investing is a necessary evil.  Such investors don't want to be bothered, and often hire professionals to handle their investment decisions.  Others love the idea of making trades, and if they encounter a winning streak, may seriously consider the idea of quitting their jobs and becoming full-time traders.  Trading is one of those enticing, glamorous careers.  The idea of being self-employed, taking vacations whenever you want, earning tons of money – it all sounds like a dream come true.

It is a dream, but the truth is unpleasant.  The average income for people who try to become full-time traders in an attempt to support themselves and their families is less than zero.  In other words, it's not that they don't make enough money to survive as a trader.  It's that they don't make any money.  The vast majority are forced to give up the dream and go back to the real world. 

We don't see people trying to practice law or medicine without the proper education, training and licenses, yet many individual investors believe it cannot be difficult to trade for a living.

There are many reasons why the majority cannot succeed as traders.  The obvious is that not everyone has the required skills.  It takes an education, the ability to understand what's required, and a special skill set to be a surgeon, professional athlete, or novelist.  The profession of trading has similar entry points.  The problem is that few believe that to be true. 

They put together a small pile of cash, make some trades and are disappointed when they realize how difficult it is.  Making money is tough enough, but when trading expenses are added to the picture, the burden is too great and profits are not achievable. 

And for those who do well, i.e., they do better than average and eke out a small profit – they never consider that choosing the wrong broker – one with high fees – may be more than enough to make frequent trading unprofitable.  Or perhaps they go the other route and sacrifice good trade execution for low rates.  Poor decisions along those lines may be enough to sink a trading career.

Trading looks easy.  You buy, and then sell at a higher price.  Or perhaps you sell short, and then buy at a lower price.  What's so difficult about that?  Those TV ads of the 1990s technology bubble convinced many that it's a cinch to get rich in a hurry.

Today's post is not about the requirements per se; it's about one simple idea that is virtually ignored by both professional and amateur traders/investors: Statistics and probabilities. 

Something as innocuous as being unfamiliar with statistics can make all the difference. Few traders have any understanding of this mundane mathematical science.  And those who may have some passing knowledge fail to recognize how vital it is to pay attention to statistics and the lessons they teach. 

Option traders may talk about probability of earning a profit for a given trade, or recognize the probability that a specific option will be in the money when expiration arrives.  However, the majority have never paid any attention to, or possibly never heard about, one vital statistic:  The Risk of Ruin.

I've published a list of my four important trading rules.  At the head of the list is the simple command: Don't go broke.  The problem is that I am guilty of not delving into how the trader avoids going broke.  Sure I talk about managing risk and being careful with position size, but there's more to it.  It's important to understand the risk of ruin.


The risk of ruin, sometimes referred to as 'gambler's ruin' is the probability of losing your entire investment account.  It's also the probability of losing so much of the account that there is too little remaining to allow you to continue trading.

There is a formula, and thus a calculator, that can be used to quantify the investor's risk of ruin.  Because gambling and investing/trading have much in common, the mathematics of the calculation are the same.  The key for investors is to translate the calculator inputs from gambler's language to investor's language.  A trusted friend has done that for us.  See Dr. Brett's description of the risk of ruin, including a link to a calculator and examples of how small changes in your approach can make a huge difference in the probability of losing everything.

This risk of ruin applies to retirees.  If you are invested and withdraw a portion of your assets every year, there is a chance of outliving your money.  That's certainly equivalent to blowing a trading account in that it's something that must be avoided.

It's important to pay attention to risk of ruin (RoR), but as mentioned previously, most traders have no idea that such a concept exists, let alone that it can be measured.


RoR calculators are designed for people who take frequent risk-taking chances.  They are appropriate for a day trader, or gambler, not for someone who travels to Las Vegas once every three years. 

Applying the numbers to investors with longer time frames is more difficult.  But, if you understand the concept, you can find probabilities that apply to your situation.

Subtle-looking changes in your trading style can make a huge difference in the probability of ruin.  The first item in the list is often the killer.  Trading with too little money makes it difficult to succeed.

The following increase the risk of ruin:

  • The size of your initial bankroll decreases
  • Trade size increases
  • Trade frequency increases
  • Your win rate decreases; you begin to win less often
  • Your 'opponent' has more money than you (in other words, his/her risk of ruin is much smaller than yours)
  • Your 'edge' decreases, and your average profit becomes smaller
  • Emotions begin to affect decisions

One reason so many trader wannabes are forced out of the game is that their initial stake (account size) is too small.  Another is that they trade too often, especially when attempting to recover losses.  When investing, your opponent can be considered to be the vast sum of money collectively owned by 'everyone else.'  There's nothing you can do about that negative feature, but you can be aware of it.

If you begin trading with emotion instead of developing a plan, your edge decreases.  That's a very quick path to losing it all.

Bottom Line

Understanding the probability of going broke is a major requirement of the wannabe trader.  I certainly wish I had been aware of these statistics earlier in my career. 

How do you use the numbers when you get them?  I have no answer to that.  If you are trading with your life savings or retirement nest egg, would you be glad to have a risk of ruin that's 'only' 3%?  Or would you consider that to be far more risk than you can afford?

One way to use the numbers is to see how the effect of position size (money at risk) makes a large difference in that risk of ruin.  However you choose to use this statistic, my suggestion is that ignoring it is not viable if you plan to have a long career as a trader.


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