Scams Companies Use to Sell You Trading Products
Learn how statistics or data are commonly maninpulated
Are great returns possible in day trading? Absolutely. There are many traders who earn a living from the markets, making returns well above the standard "10%" per year which longer-term investors have been groomed to accept. Unfortunately, the fact that some traders make above average market returns (most don't — see day trading success rate) means companies can use that knowledge to manipulate you into buying their trading products, making you think making money from day trading is much easier than it actually is.
Desire Can Be an Enemy
When something sounds too good to be true, why do we still buy it? Because we want it to be true.
While intuitively we know that spending $9.99 for a trading product has a very low probability of making us a millionaire, if it does it is a huge payoff for a small price. Most companies know there's a large group of people which will gamble a small amount of money for a huge payoff. And that these people will do it over and over again.
Been duped by a late night infomercial? The product looks great, and for $20 it's worth the risk. "What if it really is that great?" you ask yourself. Later, you realize you bought a $20 piece of junk, but there was potential there. That potential coupled with desire means you'll probably repeat the mistake.
The desire to believe is a powerful catalyst and propels us to make decisions we wouldn't usually make if that desire wasn't there. In other words, the more you really want to be a trader, or the more you really need to make some money quickly, the more likely you are to end up paying for something which may not serve your best interests.
Even those who aren't blinded by desire, but rather are logical and like to look at facts, can be duped into buying a trading product which isn't all it's cracked up to be. One of the main tools used to dupe traders and potential traders are manipulating statistics.
Here are some of the ways that is accomplished:
- Ultimately you want to your trading account to grow. A stock you bought can be up 100%, but if you're only holding a few shares and have a big account, your account won't increase in value much, even though a stock you're holding did. Trading is more than just picking winners; it's having the proper position size for your account on every trade (see how to position size in stocks, forex, and futures). Get more facts; one trade means nothing. Look at returns on account capital over many trades, not returns on a single trade (which are likely selectively picked). Dollar returns work the same way. Someone saying they made $500 on a trade doesn't tell you much without knowing how much capital they have or how much they risked to get that $500.
- Be aware of open trades. It's possible to open an account, make tons of trades and just close the winners. By selectively showcasing only the closed trades, a mischievous company can make it look like they are very successful. When taking into account the open losing trades, though, the picture is less rosy. Make sure open trades are disclosed, and the method should be transparent enough to know what drawdown those trades potentially represent. For example, if the trader only risks 1% of their capital on each trade, and there are five open trades, then the likely maximum drawdown from the open trades is 5%. If the trades have no stop loss orders or the method doesn't control risk, those trades expose the account to unlimited risk — avoid such a method.
- Win-rate is a popular statistic discussed among traders. Sales pages are riddled with flashy signs saying "We win 95% of our trades." Always consider what the winning and losing trades are worth though. Because the market constantly gyrates, you could possibly win 9 trades out of 10 by waiting for the price to move slightly onside (a small profit) and then closing out the trade. But what about the trades that keep moving against you? If you make $1 on the winning trades, but lose $50 on each of the losing trades, even though the win rate is great, the trading system is a loser. Win-rate must be always be reconciled against risk/reward.
- A common ploy by European binary options brokers is to say "Make 80% in minutes." That is true. If you place a $10 trade you will either make $8 or lose $10 (why don't they say "Lose 100% in minutes!"?). The use of percentages may make their claims seem more credible, but they are not. We want to see percentages related to account capital; the percentage portrayed doesn't give us that. It's recommended traders risk 1% of their account per trade. If you have a $5000 account, that means you can place a binary trade for $50, because if you lose you lose $50. If you win, you win 80% of $50, or $40. Your actual return on the trade (if you win), in terms of account capital, is $40/$5000, or 0.8% (very different than the 80% they advertise). That isn't very good. Traders should be trying to make 1.5% or more on a winning trade when risking 1% of account capital.
In trading, there are at least four stages a trader goes through before they "really get it." In the final stage the trader has been trading for several years and they know there are ups and downs; periods of greater and lesser profitability. Unfortunately, new traders don't know this. Within the first couple of years, if a trader sticks with it, they will likely have a stretch where they make a lot of money. Every trade seems to go their way. This can happen by chance, though, and isn't necessarily a reflection of skill. The new traders don't know this, though, so they think they have found the "holy grail of trading." Unwittingly they market their trading ideas, selling them to others. This is an innocent mistake...after all, they are making money with the method.
Unfortunately, often these methods start losing as quickly as they made it. In other words, longevity in trading is important. Strategies do have ups and downs, so often it's the longevity of the person providing the advice that's more important than the strategy itself. If taking advice from someone make sure they have at least seven years of trading experience. Seven years is what some research indicates it takes to really master a field. (Although there is some debate on that.)
While these people may object, brokers, financial planners, and mutual fund managers likely can't help you with being an active trader. What they do is completely different. Only seek advice from someone who has done exactly what you want to do for seven years or more. If you want to be a day trader, a stockbroker will have little usable data for you; the broker isn't a day trader, even though they may think they know about short-term trading. People who don't day trade are not in a position to give advice on day trading in any capacity. Always consider your information source.
Ultimately, every product has to be marketed in some way or another. Just because everything isn't revealed doesn't mean it's a bad method, person or company. Approach with a questioning mind, though. Ask questions if needed, and try not to let your own desire blind you into making a rash decision. Successful traders don't make rash decisions, so if you want to become a successful trader avoid making rash decisions during the education phase. Do that and you will be ahead of most others who attempt to conquer the markets.
For further reading on statistics and how they can be manipulated, read "The Drunkards Walk" by Leonard Mlodinow, "How to Lie With Statistics" by Darrell Huff and "The Art of Thinking Clearly" by Rolf Dobelli.