A quick flick through Twitter, any social media investing club, or investing-themed Reddit will quickly allow one to find handfuls of traders who have vastly excelled throughout a month, semester, or even a year. Believe it or not, most successful traders cherry-pick periods or use different accounts simultaneously to ensure there’s always a winning position to display.
On the other hand, millions of traders blow up their portfolios and turn out empty-handed, especially when using leverage. Take, for example, the United Kingdom’s Financial Conduct Authority (FCA) which requires that brokers disclose the percentage of their accounts in the region that are unprofitably trading derivatives. According to the data, 69% to 84% of retail investors lose money.
Similarly, a study by the U.S. Securities and Exchange Commission found that 70% of foreign exchange traders lose money every quarter, and eToro, a multinational broker with 27 million users, reported that nearly 80% of retail investors lost money over 12 months.
The same pattern emerges in every market across different continents and decades: retail traders seldom sustain profitable operations. Still, novice and experienced investors think they can overcome that bias due to ingenuity or mass marketing campaigns from influencers, exchanges and algorithmic trading systems.
Below are the 4 culprits behind the inevitable failure of retail traders. There is no easy solution aside from a long-term mentality and dollar-cost average-based strategy of buying a fixed amount every week or month.
Exchange servers have downtime and there are trade rollbacks
In June 2021, the U.S. Financial Industry Regulatory Authority fined Robinhood $70 million, alleging “widespread and significant harm” and “misleading information to millions of its customers” starting in September 2016. Specifically, the regulator cited the platform’s outages between 2018 and 2018, affecting clients’ ability to execute buy and sell orders during significant market volatility periods.
On 8 March 2022, London Metal Exchange (LME), the largest commodities trading venue in Europe, canceled all the trades in nickel futures and deferred the delivery of all physically settled contracts. The reason cited by Bloomberg was “unprofitable short positions, in a massive squeeze that has embroiled the largest nickel producer as well as a major Chinese bank.”
Notice that such a decision is vastly worse for a broker that decides to deliberately halt their platform. In those cases, at least the client can choose another intermediary. A rollback, or trade cancellation, is far more problematic because users had already expected the profits, or maybe even hedged, meaning the trade was part of a broader strategy.
High-frequency trading and unlimited funding
Professional traders use colocation servers, placing a server as close as possible close to an exchange's data center because this significantly reduces transmission delays. These exchanges offer premium services to high-end clients, including the private housing servers on-site.
Besides requiring a significant amount of volume to cover the costs, colocation servers provide high-frequency traders the benefit of running strategies such as pinging, which uses a series of smaller orders to scope whales trying to enter or exit the market.
In addition to being heavily funded, these arbitrage traders usually have additional funding from exchanges. These benefits basically mean they can post trades with no collateral, similar to having credits, providing them with a huge advantage over retail investors.
The evidence? Three Arrows Capital's (3AC) insolvency negatively impacted Deribit exchange, which was forced to cover the loss themselves. Moreover, prominent Bitcoin Cash (BCH) figure, Roger Ver, is being sued by the exchange CoinFLEX for $84 million allegedly owed due to liquidations.
Retail traders need to understand that there is no room for amateurs and realize the intricate relationship between exchanges, venture capitalists, market makers and whales. Whether or not a partnership is on paper, a mutual benefit ensures that these players have preferential access to pre-seed funding rounds, listings and market access.
The only way for investors to opt out of losing money is to give up on trading, and avoid leverage trading like the plague. In reality, investors with six months or longer timeframe stand a chance of being profitable in each of their positions.
