NeverTrade.org - A Letter to My Internet Friends

The prospect of getting rich quickly: Trading often promises substantial returns in a short period, which can be alluring to those seeking financial success. Stories of traders turning small amounts of money into fortunes are frequently shared and glamorized by the media, further fueling the desire to achieve similar success. There's actualy a name for that, the survivorship bias, as explained in the video below:

The excitement of the game: Trading can be thrilling, with its rapid fluctuations in value and the adrenaline rush of making or losing money. This excitement can become addictive, especially for those who enjoy the thrill of gambling.

Social and media influence: Trading stories, particularly those of individuals who became wealthy overnight, often go viral, contributing to the allure of trading. Social media platforms and online forums also play a significant role in promoting the idea of trading as an easy and lucrative way to make money.

Despair (a way out of financial instability): People who feel stuck in a financial rut may view trading as a potential escape to achieve financial freedom. The possibility of making life-changing profits may seem like the perfect solution to their financial woes. The video below puts precisely that perspective on the table, explaining the retail trading phenomenon from the perspective of despair:

Now that we understand the reasons people are drawn to trading, it's crucial to examine the harsh realities that often go unmentioned.

Odds are stacked against you: Between 70% to 80% of day traders lose money in the long run (source: Barber, B. M., & Odean, T. (2000). Trading is hazardous to your wealth: The common stock investment performance of individual investors. The Journal of Finance, 55(2), 773-806.). Professional traders have access to advanced tools, strategies, and information that the average person doesn't, putting retail traders at a significant disadvantage.

Let's dive deeper into the factors contributing to the unfavorable odds faced by retail traders:

Information asymmetry: Professional traders and institutional investors often have access to better information and research than retail traders. They use sophisticated tools like Bloomberg terminals and have teams of analysts working for them, providing a substantial advantage over the average trader.

High-frequency trading: High-frequency trading (HFT) firms use powerful computers and algorithms to analyze market data and execute trades within milliseconds. This technology allows them to exploit small price differences, outmaneuver retail traders, and profit from the resulting market inefficiencies.

Insider trading: Although illegal, insider trading can occur when individuals with access to non-public information use it to gain an unfair advantage in the market. Retail traders are usually at a disadvantage, as they are unlikely to have access to such information.

Market manipulation: Large market players, like hedge funds and investment banks, have the power to move markets and create artificial price movements. These price manipulations can adversely affect retail traders who lack the resources and knowledge to identify and navigate such situations.

Emotional decision-making: One study found that individual investors who rely on their emotions and intuition when trading underperform the market by an average of 6.5% annually (source: Odean, T. (1998). Are investors reluctant to realize their losses? The Journal of Finance, 53(5), 1775-1798.). Retail traders are prone to emotional decision-making, which can lead to impulsive trades, excessive risk-taking, and an inability to cut losses when necessary. This emotional rollercoaster can have a significant negative impact on a trader's financial performance.

Overconfidence: Studies have shown that overconfidence is a significant factor in retail traders' underperformance (source: Barber, B. M., & Odean, T. (2001). Boys will be boys: Gender, overconfidence, and common stock investment. The Quarterly Journal of Economics, 116(1), 261-292.). Retail traders often overestimate their abilities and the accuracy of their information, leading to excessive trading, increased risk-taking, and ultimately, financial losses.

High costs: Trading frequently can result in high costs due to commissions, fees, and the bid-ask spread. These costs can quickly eat into a trader's profits, making it even more challenging to generate consistent returns. Furthermore, short-term trading gains are often subject to higher tax rates, further reducing net profits.

Time commitment: Successful trading requires a significant time commitment, as individuals need to continuously monitor the markets, conduct research, and execute trades. This time commitment can be overwhelming and often leads to burnout or underperformance due to a lack of time and resources to keep up with the market (source: North American Securities Administrators Association (1999). Day trading: Wall Street's latest, riskiest get-rich-quick scheme. NASAA Reports.).

The illusion of control: Retail traders often fall victim to the illusion of control, believing that they can predict and control market outcomes. This false sense of control can lead to excessive trading, increased risk-taking, and ultimately, financial losses (source: Fenton-O'Creevy, M., Nicholson, N., Soane, E., & Willman, P. (2003). Trading on illusions: Unrealistic perceptions of control and trading performance. Journal of Occupational and Organizational Psychology, 76(1), 53-68.).

Trading can have severe consequences, both financially and personally. Let's explore some of the possible outcomes.

Financial ruin: Many traders, particularly those using leverage or margin, can end up losing more money than they initially invested, leading to debt and financial instability. Researc conducted by the UK's Financial Conduct Authority (FCA) found that approximately 80% of retail clients trading Contracts for Difference (CFDs) lost money (source: Financial Conduct Authority (2022). FCA highlights continuing concerns about problem firms in the CFD sector.). The following animation explains the risk of ruin in simple-to-understand terms:

Relationship strain: The stress and time commitment associated with trading can strain relationships with family and friends, leading to isolation and loneliness. Research indicates that financial stress is a significant predictor of relationship dissatisfaction and can lead to an increased risk of divorce (source: Dew, J. (2011). The association between consumer debt and the likelihood of divorce. Journal of Family and Economic Issues, 32(4), 554-565.).

Addiction: Trading can become an addiction, similar to gambling, with individuals continuously chasing losses and taking on more significant risks to recoup their money. The National Council on Problem Gambling (NCPG) reports that problem gamblers have a higher risk of developing mental health issues, substance abuse problems, and financial difficulties (source: Neal, P., Del-fabbro, P.H. and O’Neill, M. (2005) Problem gambling and harm: Towards a national definition. Final Report. Gambling Research Australia, Melbourne. ).

Loss of productivity: Due to the time commitment and mental toll of trading, individuals may experience a decline in productivity in other areas of their life, such as their career or personal development. The constant focus on trading can lead to neglecting essential responsibilities, which can have long-term negative consequences.

Mental health issues: The emotional rollercoaster of trading can take a toll on one's mental health, leading to anxiety, depression, and even suicidal thoughts in extreme cases. A study conducted by the National Institutes of Health (NIH) found that problem gamblers are at a significantly higher risk of developing mental health disorders (source: Petry, N. M., Stinson, F. S., & Grant, B. F. (2005). Comorbidity of DSM-IV pathological gambling and other psychiatric disorders: Results from the National Epidemiologic Survey on Alcohol and Related Conditions. The Journal of Clinical Psychiatry, 66(5), 564-574.).

Performance chasing: Many retail traders tend to invest in assets that have recently performed well, hoping to ride the wave of success. This behavior, known as performance chasing, often leads to buying high and selling low, as traders enter the market too late and exit when the trend has reversed (source: Grinblatt, M., & Keloharju, M. (2001). What makes investors trade? The Journal of Finance, 56(2), 589-616.).

Information asymmetry: Retail traders are at a disadvantage when it comes to access to information. Professional traders and institutions often have access to more comprehensive and timely data, allowing them to make better-informed decisions. This information asymmetry puts retail traders at a disadvantage, making it harder for them to consistently generate profits (source: O'Hara, M. (1995). Market microstructure theory. Blackwell Publishers.).

Noise trading: Retail traders often base their decisions on noise – irrelevant or misleading information – rather than on fundamental analysis. This can lead to irrational decision-making and, ultimately, financial losses (source: Black, F. (1986). Noise. The Journal of Finance, 41(3), 529-543.).

Leverage and margin trading can amplify both gains and losses, increasing the potential for substantial financial ruin. Below are some points to consider.

Exacerbated losses: Leveraged trading can lead to losses far greater than the initial investment. A small movement in the market can result in a substantial loss, potentially wiping out an entire trading account.

Margin calls: When using leverage or margin, traders can face margin calls if their account value falls below a specific threshold. This can force traders to deposit additional funds or liquidate their positions, often at a loss.

Increased stress: The use of leverage and margin can significantly increase the stress associated with trading, as traders must constantly monitor their positions to avoid margin calls and manage risk.

Traders must also contend with market anomalies and factors beyond their control, which can contribute to financial losses. Some examples include.

Black swan events: Unpredictable and rare events, such as natural disasters or geopolitical crises, can cause sudden and severe market fluctuations. These black swan events can result in substantial losses for traders who are unable to react quickly enough (source: Taleb, N. N. (2007). The black swan: The impact of the highly improbable. Random House.). To better understand black swan events, you can check out the video below:

Market manipulation: Large institutions and professional traders can sometimes manipulate markets to their advantage, creating false signals that can mislead retail traders and result in financial losses (source: Aggarwal, R., & Wu, G. (2006). Stock market manipulations. The Journal of Business, 79(4), 1915-1953.).

Algorithmic trading: The increasing prevalence of algorithmic trading can lead to sudden and unpredictable market movements, making it difficult for retail traders to navigate the markets successfully (source: Chaboud, A. P., Chiquoine, B., Hjalmarsson, E., & Vega, C. (2014). Rise of the machines: Algorithmic trading in the foreign exchange market. The Journal of Finance, 69(5), 2045-2084.).

To further illustrate the potential dangers of trading, consider the below real-life examples of individuals who have experienced significant financial losses and personal hardships as a result of their trading activities.

Case Study 1: In 2020, a trader named Alex Kearns committed suicide after mistakenly believing he had incurred a massive debt of over $700,000 through options trading on the Robinhood platform. Although the loss turned out to be an error, this tragic event underscores the emotional toll that trading can take on individuals (source: CNBC (2021). Robinhood sued by family of 20-year-old trader who killed himself after believing he racked up huge losses.).

Case Study 2: In 2015, a day trader named Joe Campbell lost more than $100,000 in a single day after short-selling a stock that soared in value overnight. His story illustrates the inherent risks involved in trading, particularly when using margin and leverage (source: Yahoo! News (2015). This Trading Mistake Could Cost You A Fortune.).

Case Study 3: Nick Leeson, a former derivatives trader, caused the collapse of Barings Bank in 1995 after hiding massive losses in unauthorized trades. His actions led to a loss of £827 million for the bank, ultimately forcing it into bankruptcy. This example shows how reckless trading can not only ruin individual lives but also have widespread consequences (source: Greener, I. (2006). Nick Leeson and the Collapse of Barings Bank: Socio-Technical Networks and the ‘Rogue Trader.’ Organization, 13(3), 421–441.).

Case Study 4: In 2012, a retail trader named Harouna Traoré lost €1 million while trading on a practice account. Unbeknownst to him, his practice trades were actually being executed in the real market. Despite his attempts to recover the losses, he ultimately faced massive financial consequences and legal battles (source: Financial Times (2018). Day trader sues broker over ‘demo’ trading platform mix-up.).

Case Study 5: In 2013, a day trader known as "F.S. Comeau" began trading with an initial investment of $130,000. Over the course of several years, he continued to lose money due to poor risk management and lack of experience. By 2017, he had lost almost his entire investment and gained notoriety on social media for his dramatic trading failures (source: Reddit (2017). User F.S. Comeau (username currently deleted, search history remaining) and the WallStreetBets subreddit.).

Instead of pursuing the high-risk world of trading, consider the benefits of long-term investing that are outlined below.

Higher probability of success: Research has consistently shown that long-term investing in a diversified portfolio is more likely to result in positive returns compared to short-term trading (source: Fama, E. F., & French, K. R. (2010). Luck versus skill in the cross-section of mutual fund returns. The Journal of Finance, 65(5), 1915-1947.).

Compounding effect: By investing in low-cost index funds or diversified portfolios, you can benefit from the compounding effect of growth over time. To better understand the power of compound interest, watch the following video:

Lower fees and taxes: Long-term investments often come with lower fees and more favorable tax rates compared to short-term trading. Thus, low-cost index funds oftentimes outperform high-cost actively managed funds.

Less stress: Long-term investing typically involves less stress and time commitment than active trading. You can focus on your career, personal life, and hobbies without the constant pressure of monitoring the market and making snap decisions.

Greater diversification: Long-term investing allows you to build a diversified portfolio, which can reduce risk and volatility over time. A study by Elton, Gruber, and Busse found that a well-diversified portfolio can reduce portfolio volatility by up to 50% without sacrificing returns (source: Elton, E. J., Gruber, M. J., & Busse, J. A. (2004). Are investors rational? Choices among index funds. The Journal of Finance, 59(1), 261-288.). The video below explains the basics of (smart) diversification in simple terms:

One of the most effective ways to achieve financial stability and long-term wealth is by focusing on personal growth and financial education. Below are some suggestions.

Educate yourself: Read books, attend seminars, or take online courses on personal finance, budgeting, and long-term investment strategies. Knowledge is power, and understanding the fundamentals of finance will help you make informed decisions about your financial future.

Develop a budget: Creating and maintaining a budget will help you track your income, expenses, and savings. By identifying areas where you can cut costs or increase income, you can accelerate your journey to financial freedom.

Establish an emergency fund: An emergency fund can provide financial security in times of unexpected expenses or income loss. Aim to save at least 3 to 6 months' worth of living expenses in a separate, easily accessible account.

Invest in yourself: Invest in your personal and professional growth by continually learning new skills, pursuing certifications or advanced degrees, and seeking opportunities for career advancement. By increasing your earning potential, you'll be better equipped to achieve your financial goals. As a starting point, the video below explains the basics of investing in yourself:

Seek professional advice: Consult with a financial planner or investment advisor to create a personalized financial plan tailored to your needs and goals. These professionals can help you develop a comprehensive strategy for wealth accumulation and long-term financial security.

Adopt a long-term perspective: Focus on building wealth over time through consistent saving, investing, and personal development. Remember that financial success is often the result of patience, discipline, and a commitment to learning.

A comprehensive financial plan can help you achieve financial freedom without resorting to high-risk trading activities. Some key components of a successful financial plan include the ones below.

Debt management: Develop a plan to pay off high-interest debt as quickly as possible. Reducing debt can help free up more resources for saving and investing.

Retirement planning: Determine your retirement goals and develop a strategy to achieve them. This may include contributing to a 401(k), IRA, or other retirement accounts, as well as developing a diversified investment portfolio.

Insurance: Ensure you have adequate insurance coverage to protect against unforeseen events, such as illness, disability, or loss of income.

Estate planning: Develop a plan to protect and distribute your assets according to your wishes in the event of your death. This may include creating a will, establishing a trust, or designating beneficiaries for your accounts.

Tax planning: Develop strategies to minimize your tax liabilities and take advantage of tax-deferred or tax-free investment options.

Education planning: If you have children or plan to have children, consider creating a plan to save for their education expenses, such as through a 529 plan or other education savings vehicles.

By focusing on these key components, you can develop a comprehensive financial plan that will help you achieve your financial goals and secure your future without relying on high-risk trading activities.

As you strive to avoid the dangers of trading and focus on building long-term wealth, it is essential to prioritize financial education. By improving your financial literacy, you can make better decisions about your money and set yourself up for a successful financial future. Here are some areas in which you should seek to continually expand your knowledge.

Investing: Learn about various investment vehicles, such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Understand the importance of diversification, risk management, and the role of asset allocation in creating a balanced investment portfolio.

Economics: Gain a basic understanding of macroeconomics and microeconomics to better comprehend the factors that influence financial markets and the global economy.

Personal finance: Develop a strong foundation in personal finance topics, such as budgeting, saving, debt management, and credit management. Understand the importance of setting financial goals and creating a plan to achieve them.

Taxes: Acquire knowledge about tax laws and regulations that impact your finances. Learn about tax-advantaged investment accounts and strategies to minimize your tax liabilities.

Retirement planning: Familiarize yourself with different retirement accounts, such as 401(k)s, IRAs, and Roth IRAs. Learn about the benefits and drawbacks of each and how they can help you achieve your retirement goals.

In addition to acquiring financial knowledge, it is crucial to develop healthy financial habits that will serve you well throughout your life. Some key habits to cultivate include the ones below.

Living within your means: Avoid the temptation to overspend and live beyond your means. Establish a budget and stick to it, prioritizing savings and investments over non-essential expenses, as explained through the following animation:

Saving consistently: Make saving a priority by setting aside a portion of your income each month. Automate your savings to ensure consistency and eliminate the temptation to skip or reduce your savings contributions.

Reviewing and adjusting your financial plan: Regularly review your financial plan to ensure it remains aligned with your goals and circumstances. Make adjustments as needed to stay on track and maintain your financial well-being.

Avoiding consumer debt: Limit your use of credit cards and other forms of high-interest consumer debt. Instead, focus on saving for large purchases and using credit responsibly.

Maintaining an emergency fund: Establish and maintain an emergency fund with enough money to cover at least three to six months' worth of living expenses. This will provide a financial cushion in case of unexpected expenses or income loss.

By prioritizing financial education and developing healthy financial habits, you can avoid the pitfalls of trading and work towards a secure and prosperous future. Remember that the path to financial success requires patience, dedication, and a commitment to learning and growth.

As you continue on your financial journey, never hesitate to seek support and guidance from friends, family, or professional advisors. Surround yourself with individuals who share your values and goals and can offer encouragement and insight as you work towards achieving financial freedom.

In conclusion, the risks and potential consequences of trading far outweigh any potential benefits, particularly for retail investors. Research-backed arguments and real-life examples demonstrate that the odds are stacked against retail traders. Simply put, trading can lead to financial ruin and emotional distress. It is important to resist the allure of quick profits and the excitement of trading, and instead focus on building long-term wealth through responsible financial planning and investment strategies.

As an alternative to trading, consider adopting a long-term, diversified investment approach, such as investing in low-cost index funds and adopting (relatively) passive investing strategies. By doing so, you can harness the power of compound interest and reduce the risks associated with trying to time the market or pick individual stocks (especially in an effort to "predict" short-term performance).

In addition to passive investing, focus on creating a comprehensive financial plan that addresses debt management, retirement planning, insurance, estate planning, tax planning, and education planning. By taking a holistic approach to your finances, you can work towards achieving financial freedom and securing your future without exposing yourself to the significant risks associated with trading.

Lastly, always prioritize personal and professional growth, seeking out opportunities to learn new skills and increase your earning potential. By investing in yourself, you can improve your financial situation and better position yourself to achieve your long-term goals.

Remember that achieving financial success requires patience, discipline, and a commitment to learning. By avoiding the pitfalls of trading and focusing on responsible financial planning and investment strategies, you can create a brighter future for yourself and your loved ones.

By sharing this letter with you, I hope to prevent you from experiencing the potential negative consequences associated with trading. The emotional, financial, and relational impact of trading can be severe, and I don't want to see you go down that path. I believe that you have the potential to achieve great things in your life, and want to see you flourish in every aspect.

I encourage you to continue learning about personal finance, investing, and wealth-building strategies that align with your values and long-term goals. Reach out to others who have successfully navigated the journey to financial freedom and learn from their experiences. Surround yourself with positive influences who support your goals and provide encouragement along the way.

Remember, life is full of opportunities, and you have the power to create a successful as well as fulfilling financial future. Stay focused on your goals, invest in yourself, always seek knowledge and growth. Your dedication and commitment to financial education and long-term planning will likely pay off in the end, providing you with the security and freedom you desire.

Please know that I am here for you, always willing to listen, offer advice, and support you in your journey. If you ever feel overwhelmed or uncertain, don't hesitate to reach out by sending an email to the address found at the very bottom of this page. Together, we can navigate the path to financial success and create a brighter future for ourselves and our loved ones.

Read This Before Ruining Your Life