No easy money: Less than 1% active traders beat bank FDs

We’ve seen a record number of new traders and investors in 2021. Despite the recent correction, Nifty 50 rose 23% for the year, so we’re still very much in a bull market for now. In all my years in the markets, I’ve seen a lot of changes, but that one thing that never changes is greed. In the long run, the stock market is probably the toughest place in the world to make easy money. Thanks to social media, countless people are lured into the markets and have a rosy view of trading. But the reality is less than 1% of active traders earn more money than a bank fixed deposit over a 3-year period.

I’ve been a trader for nearly 25 years. I’ve been tremendously lucky because I’ve had the chance to interact with thousands of traders . Here are a few things I’ve learned from interacting with all these traders and from my own successes and failures as a trader.

Have a hard stop for both your time and money

The one common thing among the smartest people I know is that they all know when to quit. Make sure to define and stick to a sensible stop loss, an amount you can afford to lose, and a time period you will wait to turn profitable – especially if you are a beginner. I was lucky to record a podcast with Jack Schwager, and one interesting thing he said was, “You should make sure that you don’t lose more than 1% of your trading capital on any trade”. The larger your losses get on a trade, the higher the chances of you acting irrationally. And for those who buy call or put options, placing a 1% stop is only possible if the buy option trades are never more than 2% to 3% of your trading capital.

Stay with the trend

A common strategy among beginners is to buy stocks at their 52-week lows. They think the stock will bounce back because it has already fallen too much. But the reality is stock prices tend to trend, i.e., move up or down in one direction for long periods. The best thing to do is to trade stocks that are trending up and sell those that are trending down.

Averaging down leads to wealth destruction

Disposition effect is the tendency of people to sell stocks that have gone up while buying or holding things that have gone down. This affects most traders, and they should be doing the opposite – cut the losers and ride the winners. Hope isn’t really a trading strategy. Buying more as a stock price falls drastically might work once in a while but is generally a losing strategy in the long run. Buying more of the falling stock is essentially you trying to fix a trading mistake, which could have been avoided by having a stop loss.

Leverage is a weapon of mass destruction

While it’s easy to get lured by the promise of making outsized gains using leverage, all it takes to blow up your account is one bad trade. This is by far the most common reason why people stop trading. Avoid leverage as much as possible. If you do decide to use leverage, use it sparingly and only when you have strong conviction in a trade and always with a stop loss.

Avoid stock tips

There’s no shortage of people claiming to help you get rich with stock tips, but it rarely works out. What makes it worse is the fact that people are terrible at following advice. So even if they do find a really good adviser, they still don’t make money. But the biggest risk is that most of the tips on social media and other groups are pump and dump scams.