June 23, 2020 - Day Trading Craze

June 24, 2020
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Think you would ever consider taking the retirement savings you’d spent a lifetime accumulating and head to Las Vegas and give the crap tables a go? Or perhaps blackjack is your game? What do you think of 2 to 1 odds on the “shoe in” Chiefs in the next Super Bowl in 2021 (or possibly 2022)? How about a day betting on the ponies at Santa Anita or Churchill Downs with money from your 401k?

“Absurd,” you say. “Who in their right mind would do that?” Well, don’t laugh too hard. There’s a securities gambling craze that broke out in this the country right alongside the breakout of COVID-19. And, we’re writing today to warn you to stay away and don’t get sucked in because short-term trading can have devastating, real-life consequences. 

 

DAY TRADING TREND

There is a mysterious and dramatic increase lately in short-term trading activity that is evidenced by empirical and anecdotal data.  Online brokers reported a dramatic spike in new accounts opened in the first quarter of 2020. Charles Schwab reported an increase of 58% over the first quarter of 2019, TD Ameritrade a 149% increase and E*Trade up 169%.

(Factset/CNBC: https://www.cnbc.com/2020/05/12/young-investors-pile-into-stocks-seeing-generational-buying-moment-instead-of risk.html?__source=twitter%7Cmain#)

 

A number of factors were cited as contributing to the increase:

  1. Commissions cut to zero by many broker dealers in the latter part of 2019 contributed to the dramatic escalation in trading volume which has only increased following the February / March 2020 market declines.

https://www.cnbc.com/2020/05/13/trading-volume-for-electronic-brokers-doubled-last-quarter-and-shows-no-signs-of-letting-up.html

 

  1. Lockdowns/Shutdowns – With sports on the back burner and being slow to return, there is a common belief that many gamblers have turned to the stock market to place their bets instead. Barstool Sports President Dave Portnoy (or better known by his trading name of Davey Day Trader Global) has been the face of this movement.

https://www.cnbc.com/2020/05/22/gamblers-pivot-to-stock-trading-during-lockdowns---barstools-portnoy-revives-old-e-trade-account.html

  1. As retail traders have opened new accounts, trading activity has spiked in recent months. Both the number of trades and trade amount have soared. In addition, smaller investors are driving a larger component of trading volume both in the equity and options markets. See the Goldman Sachs charts below:

The charts in the exhibits labeled numbers 10 and 11 were created and published by Goldman Sachs using company data as well as data from Bloomberg. 

 

THE PROBLEM WITH DAY TRADING

We have all been at a party or on the golf course and heard someone bragging about some killing they made in the stock market, or perhaps with options. They’re anxious to share their tip with you. What these braggarts never talk about are the three losers they had for every one win they scored.

Some day traders do make money. However, the odds are definitely not in your favor. One research report published by several university professors determined that in any given year, only about 13% of day traders actually achieve a profit. Even worse, the study found that less than 1% of day traders consistently make money. (Motley Fool: https://www.fool.com/investing/general/2015/10/09/why-day-trading-stocks-is-not-the-way-to-invest.aspx

Day trading websites will have you believe that the reason so many people fail is that they don’t stick to their system or they let emotions get in the way, or any number of other reasons that sound relatively easy to overcome. However, the reality is that the odds are stacked against day traders from the start, and whatever the other reasons for failure may be, it is commonly understood that the vast majority don’t consistently earn profits.

 

The day trader encounters numerous obstacles and pitfalls, not the least of which are as follows:

  1. Day trading is for the most part based purely on price action that can be driven by technical indicators, patterns, and other indicators to predict prices over the course of a very short-term holding period and ignores a long-term time horizon.
  2. In many cases, day trading essentially amounts to gambling given its emphasis on short-term price movements and often binary trading outcomes. Markets can and do move fast in both directions.  When holding securities for the longer term, as we do, we tend to overlook these gyrations.

But if you’re caught day trading during these whiplashes, a substantial sum could be wiped out in just one bad day.

  1. Many day traders don’t have an effective process to manage risk. The rise in retail trading we’re seeing is a combination of investors chasing momentum and also embracing collapsing stocks (i.e. airlines, cruise lines, and even bankrupt companies like Hertz) like never before.
  2. Most day traders are only positioned for rising prices and don’t know how to take profits when appropriate, or manage risk through options or other protective strategies.

WHAT DOES WORK IN THE LONG RUN?

The bottom line is that the lower risk way to make money in the stock market is to buy high-quality stocks, or funds that do, and hold onto them for long periods of time.  As the following chart from JP Morgan illustrates, returns tends to be more volatile in the short-term when compared to longer term holding periods:

Sticking to a long-term approach helps to keep portfolios on track by having a defined goal, risk tolerance, and asset allocation. Doing so prevents the need to chase market fads, momentum, and mania that are often not in the best interest of a long-term investor.

To reach one’s financial goals, consistency is an important component. As such, deviating from a time-tested, risk-managed approach in favor of speculation that is inconsistent with one’s strategy can adversely impact one’s returns and risk profile, particularly if the market moves against you.

 

CONCLUSION

Please don’t fall for the attractive allure of the short-term trading trap!!

If you get an urge to roll the dice, grab a little “fun money” you can afford to lose and go to Las Vegas, the racetrack, your local Indian Casino, or wherever else may excite you, have a nice dinner, take in a show, and have a terrific weekend. Leave your IRA, 401K and hard-earned life savings invested in an intelligent and thoughtful long-term strategy. 

 

This commentary is provided for general informational purposes only and should not be construed as personalized financial or investment advice.  Information has been obtained from sources deemed reliable but is not guaranteed.  Securities and investing involve the risk of loss. No strategy can assure a gain or the avoidance of loss. Any comparative indices shown are unmanaged and are provided as an indication of the performance of a given segment of the capital markets.  Indices cannot be invested in directly, and the returns shown do not reflect any fees, costs, or expenses.  Past performance should not be relied upon as an indicator of future performance.