Why do people lose money on trading? - February 27, 2019
Have you ever heard stories about self-appointed brokers losing the savings of their clients with day-trading? So did we, and the internet is also full of these stories. Why is trading so much more risky than portfolio management? Especially with non-professional self-made brokers? We have the answers for you!
When talking to people who think about investing, we often hear scary stories about how a self-appointed broker lost all or most of their savings. It’s also easy to find stories like this on the internet. There are also a lot of people looking for advice after their broker with unknown pedigree lost their money based on wrong decisions. Why does this happen so often?
Trading and investing are different
There is a huge difference between trading and investing. Trading (or day-trading as it’s often called) is based on fast-paced or precisely timed buying and selling of instruments like stocks, FX and commodities with leverage. True, this trading can lead to high profits fast but the risks (even with deep knowledge of the markets) are also very high. What does that mean? It’s easy to lose a lot (even everything) very fast.
Investing, on the other hand, is a different breed. Investing also has risks but it’s generally lower. Why? Because a good investment is planned for at least 5-years. During this period decisions are not based on fast-paced activities and opportunities but on a solidly built plan. This is not an opportunistic activity, but the nurturing of a well-balanced investment portfolio that has a steady return on the long term, which can outperform markets in good and bad times as well.
A lot depends on the broker
Day-trading is highly dependent on the brokers themselves. Since trading became super simple with the internet, many self-appointed brokers try out themselves. Some of them achieve short-term successes which they happily use for self-promotion. But a short, successful period of trading is far from long-term, stable and sustainable returns. So, when people give money to these self-appointed brokers, they take a huge risk.
In this case, people hand over their funds to a person who is not a trustworthy professional, often without written proof. Oftentimes there are no contracts, pre-defined plans and returns, and the risk tolerance of the investor is neglected as well. No wonder there are articles around the internet which detail what an investor can do if a broker fails to diversify their portfolio or overconcentrate their stocks.
Portfolio managers are safer
A portfolio management firm, on the other hand, must meet serious legal requirements. What’s more, their portfolios are based on risk tolerance, which is an important constraint to the managers themselves. They can’t take higher risks for certain portfolios than their clients agreed upon. All these rules make everything more transparent, and easier for even non-professionals to understand them.
True, a diversified portfolio may have smaller returns than day-trading, but the risks are also a lot smaller. The success isn’t based on the luck of a self-appointed broker, either. What’s more, contrary to the latter, decision making in a portfolio management firm isn’t based on emotions but on long-term goals. As discipline is one of the most important things in investing, this alone is a serious protection to an investor’s wealth alone.
Soon we will also cover the main reason why most people lose their funds on FX trading.
Disclaimer: This analysis is for general information and is not a recommendation to sell or buy any instrument. Since every investment holds some risk, our main business policy is based on diversification to minimize threats and maximize profits. Innovative Securities’ Profit Max has a diversified portfolio, which contains liquid instruments. This way, our clients can maintain liquidity, while achieving their personal investment goals on the long term.