In my last article I explained the power of frequency for traders; why taking small but frequent trades is a more professional approach. Now I want to explore some of the reasons why retail traders don’t embrace this approach.
For any of us, in any pursuit, what we learn depends on who we learn from. As I have explained in my book ‘Technical Analysis Exposed – Why Most Technical Analysis Traders Lose’, for new traders seeking education, the vast majority of courses and information are based upon technical analysis, which is not a high frequency style of trading.
The fact is that most retail trading educators do not come from the professional side of the industry. They are themselves, more like retail than professional in their knowledge and approach. Their education will typically be based on two main concepts; the (limited) knowledge they have and what retail traders want. This is what I call the financial junk food industry; an industry that gives people what they want, something that is easy to swallow and convenient but which is bad for your (financial) health.
Desire for Home Runs
As we know, higher frequency trading methods will seek out small but frequent profits. It is a style that is quite literally grinding for a living. The fact is that this style does not appeal to many retail traders.
A baseball analogy would be that retail traders try to hit home runs rather than get on base (I wonder how many traders who have watched or read Moneyball haven’t grasped what data was actually being assessed!). Retail traders too often see trading as a source of quick riches which of course it isn’t!
In addition to this desire for quick riches, retail traders typically believe one of the biggest forms of bullsh*t in the industry, namely that trading is a business of prediction. So, they seek out styles of trading that supposedly will help them predict market tops, bottoms and changes of sentiment (typically technical analysis).
The seeking of predictive trading styles is largely built on three (misguided) principles. First, that it is quite straight forward with the right indicators to consistently forecast market direction. Second, that doing so will lead to big profits (home runs). Third, that doing so will give the trader bragging rights (refer to twitter for this kind of nonsense). It is common for traders to want to tell others how they called the market right and many see this as an integral part of the business. While it is true that the standard media and social media are filled with people doing this, it must be understood ( as I explain in An End to the Bull) that these individuals are from the sell-side; they are rarely professional traders.
Trading for a just couple of ticks does not provide opportunities to brag about correct market predictions. It typically does not involve any prediction. The small profit, high frequency style of trading just isn’t sexy enough for many retail traders.
Retail Styles Didn’t Evolve as Markets Changed
At this stage, I’ll cut retail traders some slack. If we go back 25 years or more back to the days of floor trading and expensive brokers charging $50-$100 per trade, it made sense for retail traders to try more longer term approaches. The high fees meant that wins had to be of a decent size to make an overall profit while the delays in sending orders into the market (via at least two phone calls) prohibited retail traders from making fast trades. There was simply no way that a retail trader sitting at home could trade like a professional.
But the transition to electronic trading platforms and cheap commissions changed the landscape dramatically.
Styles of trading that were previously inaccessible to retail traders were now very much a possibility. So I would suggest that retail traders could have transitioned to a more professional, high frequency approach.
However, this is where the first three problems that I outlined remained in play. A combination of all or some have resulted in retail traders continuing with the techniques that they used decades ago. And let’s be clear, it is widely known that the vast majority of retail traders lose and those figures haven’t improved in recent times. But of course they won’t improve. If retail traders continue to use unreliable retail trading styles then we should expect their performance to remain poor.
Unlike 25+ years ago, retail traders have no excuse for staying with losing retail techniques and ignoring more professional approaches such as applying the power of compounding small profits with higher frequency trading. They need to understand the opportunities that now exist and evolve just as the markets themselves have.
I just did another interview with Callum Newman of Fattail Investment Research. Among other things, we discussed the use of options in trading. The interview can be seen here