By Ee Hsin Kok. Edited by Arjun Chandrasekar.
Overview
It is a pretty well-known fact that around 80% of retail traders either lose or break even in the market. But why does this happen, and how can you avoid being in that 80%? That’s what we’ll be discussing in this article.
The Market Moves Against You
There’s a famous quote by Jesse Livermore (one of the greatest traders of all time), he said:
“The stock market is never obvious. It is designed to fool most of the people, most of the time”.
And as true as it was in the early 1900s, it still remains true to this day. So why is that? Why does the market seem to always move against the majority? If prices move according to supply and demand, then shouldn’t being in the majority mean that prices move in your favor?
Well, it’s not as simple as that. Think about this: if you combined the net worth of every single person in your neighborhood, chances are you’d still have much less than Jeff Bezos’ fortune. And that’s what happens in the market. Even though retail traders are the majority of the market, they lack capital. On the other hand, the big banks, hedge funds, and market makers on Wall Street have significantly more capital than retail traders. This means they are the ones controlling the market. And that’s why the market seems to always move against you.
Market Sentiment Reports
If you don’t believe this idea that the big money on Wall Street is controlling the market, you might change your mind when you learn about market sentiment reports. Head over to dailyfx.com’s IG client sentiment report, and there you will find this chart, showing retail traders sentiment against the price movement of the market:
As you can see, over the past 6 months, as the market has grown from $3800 to $4500, the majority of retail traders have been SHORT! So in other words, while the market has been reaching all-time highs, retail traders’ accounts have likely reached all-time lows.
A Warning About Sentiment
Market sentiment reports are great because they help you understand where the dumb money is going, and where the smart money is going. But don’t use it to make investment or trading decisions. Those decisions should only be made on solid fundamental or technical analysis. If you try to predict where the sentiment indicator is going, you fall into the trap of becoming the dumb money, if you’d like to learn more about the dangers of trading with a sentiment indicator, you can take a look at this great video by No Nonsense Forex!