Why Traders Fail: The Pareto Principle

Why Do Traders Really Fail?

Depending on your goals and motivations, trading is one of the most incredibly difficult endeavors you will ever undertake.

If your goal is to have fun and feel a rush then trading will of course be easy. You won’t make any money, but like any gambling activity that produces excitement, you’ll get what you want out of it.

If, however, your goal as a trader is to make yourself financially independent and generate consistent profits over multiple years, then trading takes on an entirely different shape.

Many people have discussed the topic of the high failure rate in trading. They all mention how traders risk too much, lack edge, get too emotional, cut their winners short, let their losers run, over-trade, don’t wait for market conditions to align with their strategy, don’t have the discipline, don’t exhibit consistency, or don’t start with enough capital etc.

These are all pretty obvious obstacles to trading success, and all of them can be overcome with enough time and effort – so I don’t believe they account for the true reason why traders fail.

So in this article I will discuss my theory on why most traders fail to find success: which includes the phenomenon of Price’s Law and the Pareto Principle.

There is obviously a big difference between a hobbyist and a professional. Traders who treat trading as a hobby never make any money. That’s because the main difference between a hobby and a career is that a hobby costs you money, whereas a career generates income.

Everyone wants to be a professional athlete, or a famous actor, or a great writer, or a hilarious comedian, or a rockstar musician, or a wildly successful businessman, or a supermodel, or a professional gamer… or a profitable trader.

And everyone plays sport on the weekends, or takes an acting class occasionally, or writes short stories, or cracks jokes at parties, or plays guitar in a garage band, or works long hours at the office, or looks good in make-up, or kicks ass at video games… or otherwise dreams big.

So what is it exactly that separates those who attain the goal from those who simply want it? What is the difference between a naturally-talented professional and a doomed-to-failure hobbyist?

Let’s find out.

What Does It Take To Be Successful?

There are many prerequisites to achieving success.

The first is that you need to be in a position to achieve success. You need to be healthy (the healthier the better), you need enthusiasm and energy, you need genuine curiosity in the subject you’re pursuing, you need to be disciplined, you need to be committed, you need to have perseverance, you need to have the right education and some degree of compatible natural talent.

You also need a stable environment. If you live in a destabilized country or a wildly unstable home or family life, then pursuing entrepreneurial success will be impractical, if not completely suicidal.

Then you also need the right social network and professional relationships, the right technology and resources at your disposal, the time and space to get the many things you need to do done… you get the idea.

There are many multifaceted obstacles to success. There needs to be a lot of things going right for you before you can even set your sights on ambitious goals like becoming a millionaire or having financial independence, let alone achieve those goals.

Only once you have all or most of these things in order can you begin the process of developing experience and skill in the markets. Only once your environment, circumstances and personality are aligned with your goals can you properly begin the journey of becoming a professional trader.

Many people do not meet these requirements, are unwilling to develop them, and are therefore doomed to failure right off the bat. That probably accounts for most failed traders right there.

What Is Price’s Law?

Once you have all these prerequisites in place and you begin your journey towards trading success (or success in general), there are a number of additional factors that come into play that affect the outcome of your efforts.

In this lecture by Dr. Jordan B. Peterson he explains the phenomenon of Price’s Law and the Pareto Distribution in relation to people’s ability to perform at high levels of creative or productive output.

Jordan Peterson’s Lecture on The Pareto Distribution and Price’s Law

Price’s Law was first penned by physicist Derek J. de Solla Price. During his career as an information scientist he discovered that half of the scientific literature published at the time came from the square root of the total number of contributors.

In other words, he found that if 100 papers were written by 25 authors, then 50 of the papers would have been written by just 5 of the authors. In simple terms, this means that a minority of contributors account for the majority of contributions.

Jordan Peterson in his own studies has found evidence to suggest that this correlation between productive output and a small number of relative contributors applies to all areas of creative endeavor, not just in scientific literature.

Meaning that in nearly all careers and vocations, a small number of people account for up to half of the productive output from those roles, which in theory translates to a small number of people being more successful than the rest – not just in trading, but in all areas of life.

This concept was even mentioned in the Bible, known as the Matthew Principle – which means this principle has been understood by human beings for centuries.

For to him who has will more be given, and he will have abundance; but from him who has not, even what he has will be taken away.

Matthew 13:11–12, RSV.

This, apparently, is a natural law – not an anomaly.

What Is The Pareto Principle?

If Price’s Law dictates that a small minority of people account for the majority of productive output, then the Pareto Principle dictates that a small minority of energy accounts for the vast majority of output in all areas of life.

This article by Dean Yeong explores the subject in great detail. To paraphrase his words:

Vilfredo Pareto was an Italian engineer, sociologist, economist, political scientist, and philosopher. He made numerous important contributions to economics.

One of the most profound contributions Pareto made is his study of income distribution. He discovered that each individual’s income in a country follows a power law probability distribution from his observation that 80 percent of the land in Italy was owned by 20 percent of the population.

This pattern is named after him as the Pareto Principle, also known as the 80/20 rule.

Dean Yeong

The Pareto Principle, or 80/20 rule, means that on average, 80% of our output is derived from 20% of our input.

In other words the majority of our productive outcomes (creative achievements, money earned, points gained in a computer game, progress made towards improving our skills, etc.) comes from a minority of our efforts.

This Pareto Principle ties in almost perfectly with Price’s Law, in that the two phenomena combined seem to explain why there is such a disparity between those who succeed at something complex or difficult and those who don’t.

As Jordan Peterson says during his lecture on the subject:

What’s happening is that to do really well at a given productive task, which would also include generating money as a proxy for creative productivity, is that a bunch of things have to go your way simultaneously.

Maybe you have to be really really smart, you have to be really really lucky, you have to be really healthy, you have to be really energetic, you have to be really conscientious, and you have to be in the right place at the right time.

And maybe you also have to have the right social network. So it’s a lot of things, and each of those are small probabilities, and then if you multiply the small probabilities together you get an extraordinarily tiny probability.

You have to have all of those things functioning before you’re going to end up on the extreme end of the productivity distribution.

Dr. Jordan B. Peterson

The Pareto distribution is the effect of the Pareto Principle and Price’s Law in play. If you were to plot all traders on a graph, the successful traders who make most of the money out of the markets would make up a very small portion of the graph relative to the majority of traders who try their hand at trading.

The Pareto Distribution: Failed Traders vs. Successful Traders
Example of the Pareto Distribution as it might apply to trading

Above is an example of the Pareto Distribution. Perhaps it would be better to visualize this as a graph of money lost to the markets. The further across to the right of the graph that you are, the more money you make, but the less people are on your same level. Hence the saying “it’s lonely at the top” or “it’s a lonely road to success”.

We see this in many areas of life.

We see it occur in celebrity phenomenon, we see this in the markets (think FANG stocks), we see this in trading (90%+ of traders fail to make consistent money), we see this in macroeconomics (1% of people control a large portion of the world’s wealth), and even in creative achievement itself: the average person scores a total of zero on the creative achievement questionnaire – while a very small fraction of people score very highly across multiple domains.

We even see this in nature, almost everywhere. Here is a post on Quora that lists the various ways in which this phenomenon of the Pareto Principle occurs in the natural world.

One university student commented on that post:

Invest 20% of your time everyday in doing something that fascinates you, whatever it is, let’s say programming.

ONE DAY you will find out that you are above 80% of people in that particular field.

Divyanshu Rawat, Studied Pareto Principle

I believe this to be relatively accurate. Before I injured myself, I got really good at playing guitar. I could perform almost anything from any genre of music. And yet when I first started, I was totally clueless and hopeless at playing.

It took many years of dedication and daily practice to get to a point where I could play better than almost everyone I knew. It was not because I had some kind of natural skill, although I definitely was naturally drawn to music. Rather it was because I put in the work that many others wouldn’t be bothered to do.

Whenever I got home from work or school, rather than hang out with my friends or play video games or do normal teenage stuff, I’d literally spend up to four hours playing guitar in my room to myself (which equates to 25% of a 16 hour day, which is the average time spent awake).

It was borderline insanity and likely a form of addiction, but it paid off massively over the years… until of course I injured myself and decided to become a trader instead of a musician.

But I happen to believe that this Pareto Principle also applies to trading. It’s not enough to simply want success. We all want it, even and especially those who fail.

It’s not enough to be able to read charts and price action and fundamentals. It’s not enough to know what to do. Knowing what needs to be done, and doing it exceptionally well, are entirely different challenges altogether.

Is Your Heart Truly In It?

There are many factors that influence the manifestation of Price’s Law as a phenomenon in human achievement, such as all the ones I mentioned at the beginning of this post relating to personality, health, environment and luck.

But there is a final and major factor that influences people’s ability to achieve success in highly competitive arenas of productive output – or in our case as traders, a zero-sum game. And that is your heart.

You might have the brains and mind and a compatible disposition to become a trader. It is my belief that almost anyone has the ability to become a successful trader, so long as they have decent competence with computers and relatively complex ideas. Just like I believe anyone can become a great guitarist if they have a passion for music and they put in the proper work and practice.

But if you don’t love trading, and you aren’t willing to sacrifice significant amounts of your time and energy in order to truly master the skill, then unfortunately you are going to be trodden on by those traders who do love trading and who are willing to do the work.

Trading is not for everyone. It’s frustrating, it’s slow, it’s monotonous, it’s lonely, it’s misunderstood, it’s competitive, it’s brutal and unforgiving. But it’s also highly rewarding for those who are willing to endure those challenges.

So make sure you know where you stand long before you begin your journey as a trader. Make sure that you are in it for the right reasons.

Because if you’re not, then whenever you lose money in the markets, you will be losing it to those traders who are trading the right way and for the right reasons.

What Does This All Mean?

The Pareto Distribution means that only a few can ever end up with the goods, while Price’s Law means that only a few have the ability to endure what it takes to achieve exceptional success – and the two go hand-in-hand.

I agree with Jordan Peterson’s belief that this occurs because of the immense improbability of each person having everything aligning for them on their path to success in any given complex or competitive endeavor.

The odds of you simultaneously being healthy, in the right environment, with the right intellectual ability and the right emotional disposition, the right mentors and training, and a natural unforced passion and curiosity to excel at any given task are actually incredibly slight.

In trading this comes down to those who love trading, who are disciplined and patient and have the necessary cognitive skills to win consistently. It’s no accident or conspiracy that many traders fail while there are a remaining few who become wildly successful despite the odds.

As Warren Buffet says:

This is 100% true, but it’s also just the tip of the iceberg. The markets are also a device for transferring money from the undisciplined, the uncommitted, the unfocused, the under-prepared and the under-performing to those who have what it takes to maintain high levels of elite performance.

Your success is not dependent merely on you “having what it takes”. There is much, much more that goes into your success as a trader.

So really, it should be no surprise that so many traders fail. In fact I would go so far as to say that exactly the right amount of traders fail. Trading is great in that it allows anyone to try it. This wasn’t always the case, but with modern technology, it is increasingly accessible to everyday people.

But everyday people don’t have what it takes to be traders. Just like everyday people don’t have what it takes to be an NBA star, or a racing car driver, or an astronaut. There are unfortunately limitations around our capabilities as individuals.

So the bad news is, if you come into trading with an “everyday person” attitude and mentality, you will be steamrolled.

The good news is, if you can break out of that mentality and develop sincere specialization and skill in trading, which requires genuine passion and commitment that can’t be faked – then you stand a very good chance of success.

There’s plenty of money to go around in the markets, and if you develop the right skills and discipline to execute consistently and properly, then you’ll make all the money you deserve to make.

That’s the beauty of trading, and what makes all of the effort worthwhile. There is no cap on your pay, other than the capital that you can trade. But you don’t need to ask anyone for a raise. You don’t need to negotiate with anyone to get what you’ve earned.

You just need to put in the work on yourself and your process, be patient and realistic with your expectations, and as a result over time you will significantly outperform and out-earn the thousands of traders who aren’t capable of doing all of that.

How To Achieve Success Despite the Odds

Admittedly, some of this research is disconcerting. To a large degree it means that natural laws govern how much we can and can’t achieve.

But we’ve always known this to be true, despite our reluctance to acknowledge it. We are all painfully aware of our own limitations. And it’s no secret that life is often arbitrary and indiscriminate in how it dishes out rewards and punishments.

Just because you want something badly, and you’re willing to sacrifice everything to get it, doesn’t mean you are guaranteed to get what you want. There’s still a chance that despite your best efforts, you won’t get it.

But the good news is, if you do everything in your power to set yourself up for success, and you commit to the long-term goal and you are rational in your expectations and your efforts to achieve them, then the chances of you being successful skyrocket.

This is because most people simply aren’t willing to put in that much work to be as good as you are. By merely committing to becoming a successful trader and truly putting your heart and soul into performing your tasks to the best of your abilities, you effectively reserve your seat at the table of success.

Because of Price’s Law and the Pareto Principle, every tiny improvement matters a ton in a relative environment.

Dean Yeong

If you want to achieve success in spite of all the obstacles that you will inevitably face and pop out on the correct end of the Pareto Distribution, then you need to align yourself totally with your aims.

Set a meaningful goal that you find extremely valuable. Make it one that will motivate you to get out of bed every day and get going. It needs to be a goal that, if you were to achieve it, would make all the suffering in order to get there worthwhile.

Also spend time reflecting on the things that would prevent you from achieving your goals. In the case of trading, maybe that’s risking way too much on a single trade, or breaking your rules and taking a trade you shouldn’t be in, or some other form of self-sabotage.

You need to reflect on these issues until it makes total obvious sense to you to not do that behavior. You need to dive really deep into the whys of your trading.

As Nietzsche once said:

He who has a why can bear almost any how.

Friedrich Nietzsche

If you can’t bring yourself to do all of this, then you will never make it past the many obstacles that present themselves. Your heart is simply not in it. If you can’t do the work required to get better, and you are losing money trading, then it’s possible that you aren’t meant to be a trader.

There are easier ways to make money, believe it or not – so if you came to trading as a get-rich-quick vehicle, then it would be wise to reconsider your plans. The markets eat people who want to get rich quick.

In any case, you can’t force your interests – you must choose ones that are not only within your realm of competence, but also ones that spark a natural curiosity in you.

This is the hardest part of all because it can’t be taught or manifested by willpower alone. It requires reflection and deep thought and a lot of external influences that could be described as fate. If it’s your fate to be a trader, then you will know pretty quickly.

For me, I knew I was destined to be a trader when I blew my first account. Ironically, this experience sparked a drive in me that I couldn’t extinguish.

My first thought was not to blame the markets or even to beat myself up too bad. I just had this overwhelming feeling inside of me that even though I had just failed as a trader in the most literal manner possible, I could’ve done much better if I’d known more about what I was doing.

My head filled with reasons why it happened to me, and how I could avoid it happening again. So when I blew my second account and felt that feeling even stronger (whoops), I knew for certain that this was for me. I was going to become a trader. And thankfully, I haven’t blown an account since then.

When you can trade every day for 12 months straight getting your ass kicked and losing all your money twice, and then come back for more – not because you enjoyed the excitement or you want to revenge trade, but because you genuinely want to get better at the game – then that’s when you know you’ve found a game that truly interests you.

Now I’m not suggesting that you trade recklessly for a year and blow a few accounts in order to discover whether or not you truly love trading. But I’m sure there have been occasions where you messed up during your learning process and you had the opportunity to quit, give up, or simply fail to learn anything.

If you turned that moment into an opportunity to improve yourself and get better at the game, then if you ask me, you’ve already passed the test. You are destined to be a trader.

That spirit alone sets you apart from 90% of the other traders. And it may be that spirit alone that makes all the difference between successful traders and unsuccessful traders.

If you have the right spirit and attitude, then all that is left to do is account for your weaknesses, develop micro routines and habits that set you up on the path for success, and generate positive feedback loops wherever you can.

Don’t just compound your capital – compound your wealth of knowledge and skills, too.

I’ve always had the suspicion that what happens to people is that as they move towards zero, positive feedback loops get set up so that they’re more likely to hit zero. And as they move away from zero, positive feedback loops are set up so that they’re increasingly more likely to move away from zero.

Dr. Jordan B. Peterson

Never fall to zero.

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Nerfx shan
4 years ago

The picture illustration above I strongly agree, as if I do not believe that it turns out when trading if management is not good without us realizing I risk large funds with inadequate skills, as a result until now even though I know my mistakes I also still often loss, sometimes if my loss surrender and not stopped but until exposed to the margin. But strangely I just regretted later. That is my story for a number of times with a margin call … Thank you for the article, hopefully by reading a lot of references from you, I can… Read more »

4 years ago

I found your blog doing forex and probability searches. I am a beginner but I really agree with almost everything I have read at the moment, by myself I have reached similar conclusions. It is all very reasonable. And I think it’s the only way to win in the long term.
Greetings and many thanks