Trading Will Bankrupt you – Yes, you

Cryptocurrency Index Fund, Invest, Learn

Ninety-five out of one hundred investors lose money trading. One reason for this is that like novice horse-riders they are just very bad at it. However, horse-riders can practice until they get better but traders stop because they run out of money (I know I did).

So why is it that smart people can lose money so quickly?

You won’t get average returns when trading

Those of us who can remember our high school maths may remember that a set of results such as investment profits has a mean, median and mode.

Mean profit (or Ensemble average)

The average profit of many trades

Median profit

The middle result in the list of results arranged from smallest profit to biggest profit

Mode profit

The most frequently made profit

Distributions

You might also remember that the results of a set of purely random events will form a Normal Distribution which looks like a bell. For the Normal Distribution the mean, median and mode are all the same which is either interesting or boring depending on your viewpoint.

However, real-world distributions like trade profits are not Normal Distributions and the Mean, Median and Mode can be very different.

For example, 1 million investors buy a lottery ticket for a $1. The winner gets $1m and therefore the Mean profit will be zero but both the Median and Mode results are to lose $1. We can see that if want to understand what OUR OWN experience is likely to be we must consider the Median and Mode experiences not the Ensemble Average. The statistics show that active trading is like this example; a few people make money while the vast majority don’t.

At this point, you may well say “I have superior judgement so I will be the lucky winner”. In my view that won’t happen because the markets are rigged but let’s take that claim at face value.

Time Averages will kill you

In the words of Dirty Harry (sorry to the readers under 50),

Uh uh. I know what you’re thinking. “Did he fire six shots or only five?” Well to tell you the truth in all this excitement I kinda lost track myself. But being this is a .44 Magnum, the most powerful handgun in the world and would blow your head clean off, you’ve gotta ask yourself one question: “Do I feel lucky?” Well, do ya, punk?

I are now going to show the role that bad luck has in trading and how it ensures your downfall over the long term.

We know that market contains some good investments, some average investments and some that are actually worth nothing. Obviously we can’t actually tell which investments are worth nothing. If anyone could actually tell, word would get out and they would go bust. Our skill and judgement are not going to help us, we have to rely on good luck.

Let us say that 1% are worth nothing in the long-term (in venture capital markets such as crypto it is probably 99%!)  and that if we buy them we will lose our whole stake become bankrupt and be out of the game.

Making a single investment is like playing a game of Russian roulette where the player loads a single bullet into a revolver, spins the chamber, points the gun at his head and fires. In our example we have 1% chance of a getting a bullet (bad investment).

The problem is that we don’t only play the game once, we just keep spinning the chamber and pulling the trigger each time we make a trade. We might last 10 spins, or 100 spins or 1000 spins but eventually there is a bullet with our name on it.

The Time Average gain from 100  investments one after the other is very different from the Ensemble Average of  100 investments made at once. The Median and Mode returns shrink as time goes on – you will go bankrupt.

Index funds make money with less risk

I have shown that it is very unwise for anyone without insider information to trade actively. This is because active trading results in modal gains and is subject to Time Averaging resulting in you eventually losing all your investment.

If you insist on trading you can reduce these risks by diversification. In my Russian roulette example the investor choose only a single investment on each spin and was easily bankrupted. If he had chosen 2 investments the both would have to fail for him to be ruined. If he had chosen 10 investments on each spin, all 10 would have to fail. Successful traders will often have 20 active trades and a maximum of 5% of their bank roll at risk in any one trade.

So what is the optimum number of investments to avoid ruin? The answer is to buy a small amount of every investment on the market and the easiest way to do this is to buy an Index Fund. This ensures that you will get Ensemble Average returns before fees.

Trading is called “active investment” because you have to work to manage your holdings and worry about them. Owning index funds is called passive investment because you have to do anything to get average returns. Average returns are boring and boring is good.

My personal view is that the best conventional index funds are the Vanguard LifeStrategy range and the best Cryptocurrency index fund is Crypto20. Obviously crypto is many times more dangerous than conventional investments and many advisers would suggest it should not form more than 5% of your savings.

and because you don’t believe me

The only way that most people (including me) to get it into their thick skulls that active trading is a waste of time and money is to try it. A few early wins and a bull run will convince them that they are genius traders and long-term experience will change their mind. Therefore, have a go, open an account and put in $1000 and see how long it takes to lose it. If you only lose $1000 you have done well, most people pay much more to learn the lesson.

Additional reading

I was prompted to write this post by this excellent article.

You Are Not a Monte-Carlo Simulation

Author

James Bayley

Ex-physicist, professional project manager and cryptocurrency enthusiast.

Related Articles

3 Comments

  1. Zephy 2018-05-07 at 11:10 am

    “A few early wins and a bull run will convince them that they are genius traders and long-term experience will change their mind. ”
    That is me. I had to learn it the hard way.

    Great article James. I will be coming again for more inside info. I am an investor of C20 and I have been wondering if it is worth the risk buying more or buying individual coins entering the market.

    Zephy

    • james_the_admin 2018-05-07 at 11:59 am

      In my view you should only trade actively if you have information that is not available to the market in general. For example, suppose you are an expert on Ethereum and you find a bug. You know this will move the market when others find it so it is sensible to sell Ethereum. Another example is that you might follow Dash closely and think that it is undervalued now because they will have a big marketing campaign in Q3 and so you buy Dash. The important thing is that these active trades should only be a small proportion of your entire portfolio. Our goal is to avoid huge losses arising from a lack of diversification.

      You can decide not to trade actively but still hold more coins. For sometime I held 20 individual coins and I would weight the ones I thought would be winners. It took a lot of effort and I did not beat the market. C20 was easier. You must remember that C20 is a risk, the team could steal your investment and do a runner. I would strongly recommend holding some of the top 20 coins in a hardware wallet so you are not wholly exposed to C20 risk. Trezor and Ledger lets you hold BTC, LTC, DASH, Zcash, BCH, BTG, ETH, and ETC securely and this lets you diversify your risk.

    • james_the_admin 2018-05-07 at 12:00 pm

      One thing I should add is that some people like gambling. By all means buy some small coins because it is fun, just don’t think it is investing for the future. Cheers James

Leave a comment

Disclaimer

This site provides educational material only and nothing herein constitutes investment advice. You must conduct your own due diligence before buying any cryptocurrency related product and should consider taking professional advice.

Privacy Policy

Warning

Cryptocurrency investment is very risky and you may loose all your money. Risks include but are not limited to, theft, fraud, exchange failures, and technical errors leading to partial or total loss of funds. Never invest money you cannot afford to lose.

Terms and Conditions

(C) 2017 Cryptocurrency.guru

Back to Top