Looking to go broke in a hurry? Try day trading. The excitement of always being in a trade is an emotional trap that almost always gets such investors into trouble. That, coupled with the stock market’s ruthless efficiency, pretty much ensures that every rapid-fire trader is going to be a loser. Or so we’re often told.
Not necessarily, say Yi-Tsung Lee and Yu-Jane Liu of National Chengchi University in Taipei and University of California professors Brad Barber and Terrance Odean in their joint paper, Do Individual Day Traders Make Money? In fact, the authors claim, there’s evidence that day trading can be a winning strategy for certain investors, providing they commit the required time and acumen to building superior skills. But amateurs will definitely lose out, they add.
Long-time veterans of behavioural finance, Barber and Odean have tracked the moves of individual investors several times before, publishing studies showing that investors generally lose money by trading too much and that the ease of trading online has only exa-cerbated this money-losing tendency. People who switch from phone-based stock trading trade more often, more speculatively and less profitably online, the professors have discovered.
Why? Such traders have too much faith in their own abilities, and that leads them to make more poor trades, Barber and Odean have found.
In another widely publicized Barber and Odean study, the authors analysed trading records of 10,000 accounts at a large discount brokerage — almost 100,000 transactions altogether. They discovered that, on average, the stocks purchased underperformed stocks sold to finance those purchases.
In other words, the investors would have been better off holding on to their stock rather than trading into different ones.
Looking further into the excessive trading, Barber and Odean discovered that investors tend to sell winners and hold on to their losers. Even when eliminating trades that might be motivated by liquidity demands, tax-loss selling, risk reduction or portfolio rebalancing, the results hold true. Heavy trading lowers returns, the authors maintain.
More recently, in the course of doing research for the Taiwan Stock Exchange, Lee and Liu were given access to a gold mine of data, the full exchange trading records for a full five years, including individual identities. As no similar data have been available in the U.S., the four researchers pooled resources to see if they could find evidence of traders who came out ahead.
They began by counting some 925,000 individual investors on the exchange in a typical month. They then identified the heaviest traders, a group that accounted for more than half of all individuals’ day-trading volume. This group did buy and sell stocks at a profit most days but, after transaction costs, most lost money.
Checking to see if past winners kept winning, the researchers then ranked all traders by their success over the prior six months, splitting them into six groups. The top-performing group went on to see average daily gains of US$251, even after costs. At annual rates, that comes to more than five times the annual per-capita income in Taiwan. The second-best group also netted gains, but just $48 a day, while the third group lost an average $45 a day.
Overall, 82% of all traders lost money. Assuming the makeup of Taiwanese traders is at least similar to traders on this continent, the most recent study confirms previous Barber and Odean results.
The odds are so grim, in fact, that the latest study suggests only a few savvy investors should even consider day trading. Yet, not every day trader is a complete fool. Left for future research is whether specific strategies — trading just a stock or two daily, for instance — are more likely to produce winners. IE
Day trading not the route to riches
Studies show most day traders have too much faith in their own abilities
- By: Gordon Powers
- December 5, 2006 October 30, 2019
- 13:13